When inflation is raging in an important election year, the best political move may be to outsource the fight to central banks. After all, price stability is a huge part of their job. Government leaders might discover, though, that the cost of curbing inflation is an ugly recession. It is unclear whether they are prepared to handle that outcome.
With price increases running at the fastest pace in decades across Europe, the Americas and the Antipodes, there is good reason to let monetary chiefs get on with their task absent political pressure. Central banks, in theory at least, are able to move quickly and free of the horse-trading that comes with legislative solutions.
For governments, it is a win-win: They get to shift the blame for any failure while basking in the event of success. There was a strong whiff of such empowerment in President Joe Biden’s remarks to Federal Reserve Chair Jerome Powell on Tuesday. “My plan is to address inflation,” Biden declared. “That starts with a simple proposition: respect the Fed, respect the Fed’s independence, which I have done and will continue to do.”
The Fed’s autonomy is held as the gold standard in many parts of the world — as much as Donald Trump abused Powell and floated the idea of ousting him. (Even in the best of times, this independence isn’t completely pure, and Fed officials pay close attention to the mood in Congress.) So why did Biden feel compelled to emphasise that Powell had a free hand? The Fed chief would have recognized the opportunity and peril implicit in those comments. Go ahead and tighten as much as you want but it is on you, might have been one subtext.
Sure, elected leaders want inflation to come down, but they also love a strong labour market and hate recessions. Is Biden prepared to pay the ultimate price for telling Powell to have at it? I am sceptical.
Powell probably does not want the R-word, either. But he is already keenly aware that the global economy is losing altitude. China will struggle to grow much this year and recession is on people’s lips in the UK. Inevitably, analogies have been made to Paul Volcker, the Fed chair from 1979 to 1987 who broke inflation at the cost of a deep slump — and had his own share of uncomfortable chats at the Reagan White House. Polls already look dire for Democrats in November’s midterm elections. Slowing growth and a cooler jobs market won’t exactly help.
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As heroic as Volcker was, he may not be a perfect analogue for the current moment. (He died in 2019.) The world of the early 1980s was fairly contained: The Cold War was fought intensely and half of the globe barely had capital markets. China was a minnow. Volcker struck when he did and with great force because inflation had been left to fester for at least a decade. That is not comparable to the situation now, wrote Ethan Harris, global economist at Bank of America Corp, in a recent note. “The last thing the world needs now is a Volcker-size policy shock,” he noted. He “more-or-less deliberately created one of the biggest recessions in modern history. This time is different.” Supply-chain bottlenecks — central banks can’t do much about those — have probably peaked and a key measure of inflation is likely to retreat by year-end. A policy-induced downdraft may be a problem for next year, reckons Harris.
Biden’s remarks should also be seen in the context of a broader defensiveness in Washington. Earlier this week, the president penned an op-ed for the Wall Street Journal on how he will lick inflation. The monthly employment report, perhaps the most political economic release until inflation flared, is due Friday. Top officials have been careful to say that job growth is likely to slow and Biden painted that as “a sign that we are successfully moving into the next phase of recovery.” It appears to be a good time to get mea culpas out of the way. Treasury Secretary Janet Yellen told CNN she erred in predicting last year that elevated prices would be short lived.
Yellen, who preceded Powell as Fed chair, was in good company. Central banks around the world were taken aback by the absence of inflation in the aftermath of the 2007– 2009 Global Financial Crisis. Rising prices didn’t actually lurk behind every upbeat number. That led policy makers, from Sydney to Frankfurt, to focus on running the labour market hot. They declared a preference for outcomes, not projections.
The risk now is that if authorities wait for clear and unambiguous signs that inflation is off the boil, they could miss the turn in the economy to the downside. That could leave them cutting rates more than they otherwise might have. The cycle would repeat itself. Independence became an attractive way to set the price of money because central banks could act quickly, if required. That assumes they aren’t still fighting the last war vigorously. — Bloomberg Opinion
