Along with the pace of tapering, the big question in US monetary policy right now is whether Joe Biden will replace Jay Powell as Fed chair. But Edward Price, a former British economic official and current teacher of political economy at New York University’s Center for Global Affairs, argues that — from a monetary policy perspective — it doesn’t matter who heads the Federal Reserve.
Truth be told, it doesn’t really matter who runs the Fed. Should that vex, consider this: if modern central banks are independent, why do they act as anything but?
The evidence for this charge is plentiful.
Today, low policy rates are no longer a countercyclical tool. Instead, they are a structural feature of the financial system. Want to counteract a financial crisis? Low rates. Want to sidestep a market meltdown? Low rates. Want to encourage the labour market, tout consumption, protect the debt stack, banish a pandemic or save a single currency? You guessed it. Low rates.
In fact, central banks appear studiously indifferent to the business cycle. Instead, over the past decade of swelling balance sheets, central bank swap lines and near zero interest rates, monetary accommodation has become a simple fact of life.
Is this how central banking was supposed to work? Probably not.
Let’s remember the basic plan. The third stab at creating an American central bank occurred in 1913 in a bid to tackle perennial banking crises and to introduce some degree of deflationary policy control over the US financial system. This was a countercyclical goal. If private actors introduce excessive inflationary pressures, and then panics, the Fed’s job was to counter with monetary policy. In 1977, however, the Fed was given a second job: targeting full employment. If the private sector can grind to a halt, the Fed, it was determined, should inject inflationary pressures to counteract those too.
The result was the dual mandate that targets both financial stability and full employment. Regrettably, however, the mandate is a contradiction in terms. The first task, encouraging activity, undoes the other task, discouraging the same. In fighting the worst excesses of the business cycle, the Fed must encourage its worst insufficiencies and vice versa. There is always either an inflationary or deflationary drift. As a result, the Fed’s actions can easily be procyclical.
As such, sceptics have long suspected that central bank independence isn’t worth spit. Instead, the de facto reality is simple. If their aim is cheap money, presidents and Congress alike will bash the American monetary authorities into submission. This may be so. And eventual inflation is certainly convenient for governments mired in debt. But the ultimate source of what we might call the Great Accommodation is far simpler than that.
To coin a phrase, it’s the international dollar standard, stupid.
Since the 1970s, the combination of fiat currencies, floating exchange rates, international capital mobility, financial innovation and post-crisis monetary policy have led us down the path of pecuniary profligacy. Call it currency wars or quantitative easing (QE). Call it an accommodative posture or animal spirits. Call it a flexible average inflation target (FAIT) or call it securitisation. Call it what you will. The demon of currency debasement goes by many names.
Here’s the truth. The 2006 asset bubble never burst: it was simply transferred from private to public ownership, from an assumption the Fed would bail the system out to the reality that it did. In fact, during the Great Moderation, an unregulated American financial system intervened — unchecked — in the prerogatives of the Fed. In essence, it printed excessive claims on dollars. When things went south, in 2007-8, the Fed rushed to fill in the gap. We might call the result not so much inflation targeting as asset-price targeting and not so much balance-sheet policy as balance-sheet capture.
Still, we have no choice. As the economist Robert Triffin pointed out, if the dollar is to survive in the world it must be both omnipresent and omnipotent. But if omnipresent, its omnipotence is greatly reduced. Supply enough dollars and, eventually, dollars won’t be worth much. Alas, the same is true in reverse. Protect dollar omnipotence, by curtailing the dollar supply, and dollar omnipresence vanishes overnight.
Meanwhile, the tottering US debt structure is plain for all to see. Nobody imagines serious tapering, or significant hikes, even if the market has an occasionally freak out. It’s hard to escape the obvious conclusion. Whoever runs the Fed doesn’t matter. A dove, or a dovish dove. Take your pick. They must continue the dollar’s expansion or face ruin.
What kind of ruin? Again, you name it. In this environment any sort of hike would cause a down cycle or even a crisis. In recent years, policymakers have discussed the ‘zero lower bound’ exhaustively. But the lower bound may be far less worrisome than whatever the ‘𝑥 upper bound’ may be. Presumably, there is some higher Federal Funds Rate that would see the financial system, and debt structure, collapse. What is this upper bound? A Federal Funds Rate of 2 per cent? Of 1 per cent? Who knows? There may be no policy space below us, but there’s also very little above.
Is everyone concerned? Not at all. The Fed claims recent inflation is transitory and its forecast is still muted for the rest of 2021. Sundry academics write at length about how dollar dominance has no alternative. Many think central bank independence is alive and well. As a recent Financial Times editorial has put it, “the Fed’s independence [is] intact, [and] on Powell’s watch it has used that independence to shift its policy framework in a markedly dovish direction.” Unfortunately, that’s another contradiction in terms. Avoiding markedly dovish directions is exactly what central bank independence was for.
Never mind. None of this will last forever. To paraphrase Leon Trotsky, the dollar may not be interested in inflation, but inflation is certainly interested in the dollar. At some point in the 2020s, expect runaway prices, a fiscal roll back, swift interest rate hikes, a stock market implosion, a period of low growth and, whisper it, even international capital controls.
Until then, the Great Accommodation will continue. Continue, that is, until one day the hawks swoop down and the doves scatter. Then, whoever runs the Fed may matter once again.