The Fed and the ECB should keep away from changing into fixers of final resort


Jerome Powell, chairman of the U.S. Federal Reserve, pauses while speaking during a news conference following a Federal Open Market Committee meeting in Washington, D.C., on Wednesday, Sept. 18, 2019.

Andrew Harrer | Bloomberg | Getty Images

“I knew they would cave in.” That was the cutting remark from an old Wall Street hand to one of my first forecasts that none of the economic indicators justified an imminent interest rate cut by the U.S. Federal Reserve.

Since then, stunning memoir revelations of the U.S. president’s direct orders for credit easing to an independent agency of the U.S. Congress made me more sympathetic to the difficult position of my former Fed colleagues.

But I always wondered why the Fed rarely, if ever, used the opportunity of fighting back with fully documented arguments in defense of its policy stance.

On the face of it, that would seem like an easy thing to do. The monetary policy is only one of the three main levers of economic management that include fiscal policy — such as taxes and public spending — and structural policies. The latter can be broadly defined measures to remove technical and institutional obstacles to the free functioning of demand-supply forces in labor and product markets.

Explain things to Main Street

Why is it, then, that the Fed fails to remind the public when government officials and asset traders start clamoring for cheap, or even free, money?

Perhaps naively, that is still an enduring mystery to me.

The Fed’s unnecessarily terse and technical policy statements are obvious put-offs to the general media that are supposed to inform the public at large about what its monetary authorities are doing — that includes the costs of credit that affect families’ mortgage rates, car purchases, home furnishings and entrepreneurial endeavors. When you add it all up, credit costs are directly driving some 85% of the U.S. economy.

Congressional hearings are also of limited utility, since most of their focus is on what the Fed will do next. The Fed won’t talk about it because that’s for its policy forum to decide.

But the Fed’s public statements must explain its policy in terms of economic activity, employment and key inflation indicators. That logically leads to the discussion of credit policy constraints presented by budget deficits, public debt and structural demand-supply imbalances affecting inflation pressures in labor and product markets.

In other words, that should be the Fed’s “over-to-you” message for the White House, the Congress, the financial markets and, most importantly, for American voters and taxpayers.

Again, such a simple piece of Fed’s economic pedagogy is not a call for confrontation.

That would just be a way of explaining to the public that the Fed’s action is only part of a total policy mix, which includes fiscal and structural policies.

It would also serve as a reminder that a sustainable full employment and price stability cannot be delivered by monetary policy alone, because that requires balanced public sector accounts, a pool of available and skilled labor, and competitive markets for goods and services.

Tell Germany like it is

The European Central Bank — the only true savior of the European economy — is a much more flagrant case of poor communication with the public in the 19 countries of the monetary union.

It took a retired former vice president of the ECB to tell the Germans — ringleaders of trade and budget surplus countries — that their refusal to use fiscal policies to stimulate the euro area economy forced the monetary authorities to maintain exceptionally easy credit conditions.

The ECB has failed to explain that the euro zone’s ongoing cyclical downturn, and another round of crisis management via quantitative easing, were brought on by policy disagreements within the monetary union. That has now led to blaming the European growth recession on the U.S.-led trade disputes and a deteriorating security outlook in the Middle East, Persian Gulf, etc.

Meanwhile, the German and Dutch surplus runners keep pouring scorn on the ECB for negative interest rates and Germany’s rising real estate prices that seem to be caused by years of supply shortfalls rather than strong demand upswings.

All that is very strange for a genuinely independent supranational institution whose sole mandate is to deliver price stability informally defined as a medium-term consumer price inflation between 0% and 2%.

In a situation where the monetary policy is being attacked for scrupulously pursuing its policy mandate, it should be so easy for the ECB to explain that an extremely accommodative credit stance is needed to offset the euro area’s tight, pro-cyclical fiscal policy that is depressing demand, output and employment.

As an aside, one should also note that the White House should come in on this, because the German-Dutch mercantilism is killing the markets which take a quarter of American exports.

Investment thoughts

The Fed and the ECB should clearly communicate to the general public that monetary policy is only one of the instruments of economic management. That means that coordinated monetary, fiscal and structural policies are necessary to produce a steady and sustainable growth of demand, output and employment in an environment of price stability.

Failure to clearly explain that simple fact leads to distorted asset price expectations, based on guesses about central banks’ actions as fixers of last resort (aka central bank puts).

More importantly, an apparently entrenched idea that cheap money alone is the answer to all economic problems puts huge and permanent political and social pressures on monetary authorities. That typically leads to policy errors that exacerbate business cycle fluctuations and put a big question mark over the central banks’ credibility.

To make their case, central banks need no confrontation with executive and legislative authorities. They just have to make clear that the monetary policy is calibrated by taking into account the fiscal and structural conditions of the economy.

Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York, and taught economics at Columbia Business School.



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