How not to weaken the central banks' independence

T HERE is more than any echo of the Nixon era in Donald Trump's presidency. Monetary reverberations are among them. In 1972 re-election, Richard Nixon felt he needed a strong economy on his back, and made a habit of haranguing Arthur Reserve's chair of the Federal Reserve at that time. Burns told the meetings in his diaries: "The president looked wild; spoke like a desperate man; fulminated with hatred of the press; took some of us to task …" Historians believe Burns was to accommodate Nixon's demands and helped launch inflation in the 1970s. Mr Trump is now making his own attack on Fed's independence. He has repeatedly complained about the central bank's decisions and urged it to take a deaf attitude.

More striking Mr Trump, who has already chosen three of the five members of the Fed's board, has named Stephen Moore and Herman Kain to fill the remaining two vacancies. Unlike candidates who have come before, both are political activists. But the parallel with the 1[ads1]970s is less suitable than it seems.

Nixon's inflation helped inform modern ideas of central bank independence. In 1977, Finn Kydland and Edward Prescott, who won the Nobel Prize in 2004, published a seminar on the problem of "time relationship". Governments can promise to keep inflation low, they argued, but that promise becomes more difficult to keep as time goes on. When the public expects low inflation, the political benefits of achieving an outbreak of higher than expected inflation are reducing the real (inflation-adjusted) value of debt and generating a short-term increase in real income and output. As governments facilitate the temptation to inflate, expectations and inflation, which are necessary to surprise the public, adjust even higher. In the absence of a mechanism to keep inflation low, prices accelerate. Along with political rules and inflation targets, the central bank's independence became one of the ways in which the government's promise not to blow on was made credible.

Yet, although independence became more common, it became incomplete. Governments are often responsible for setting central bank mandates, appointing heads, and deciding which tools they can use to do their jobs. Many of the elected leaders have surrendered the temptation to jawbone monetary policy. In the months before the 1992 election, George H.W. Bush urged Alan Greenspan to cut interest rates; he later blamed the Fed for his losses at the polls. In his memoirs, Paul Volcker remembers an unpleasant encounter with Ronald Reagan and his chief of staff, James Baker, where he was ordered not to raise interest rates during the election in 1984. During the financial crisis, central bankers around the world came under fire from politicians for having allowed financial profit to build up, knock out banks during the crisis and use unconventional measures to support damaged economies.

These political intrusions did not prevent central banks from keeping inflation low. On the contrary, economists are increasingly predicting stubbornly low levels of inflation, interest and growth showing that the need for independence was exaggerated. Inflation was high around the world in the 1970s. Perhaps instead of a guilty Fed leader guilty, the problem lay in factors specific to that period, or a poor understanding of the relationship between monetary policy and inflation.

In view of today's chronically low interest rates, central banks may have to revise their political framework conditions to stop the slump economy. But without crushing politicians, they can be too institutional conservative to do so. Shinzo Abe, Japan's Prime Minister, won elections in 2012 on a promise to rejuvenate the economy, and immediately pushed the Bank of Japan to be more eager. The result has been impressive growth instead of a macroeconomic disaster. Structurally low interest rates also mean that central banks need more help from fiscal policy makers when demand escapes. The cooperation will inevitably weaken the central banks' institutional independence.

Fool's mandate

Can one argue then that by pressing the Fed to help his re-election campaign, Trump undermines a norm that has survived its usefulness – even though he could help America complain his way out of the low frequency trap that has involved most of it of the rich world? In fact, the election of Mr Moore and Mr Cain suggests that a completely different form of politicization is at work. Neither is a professional economist; both have worked extensively in Republican politics. Mr Moore informed Mr Cain during his campaign for the Republican presidential nomination at the 2012 election, which was tracked by a promising start of allegations of sexual harassment. Both have expressed monetary policy positions that can mark them as hawks. In 2008, when the US economy was on the verge of a deep recession, Moore said the Fed should raise rates rather than cut them, predicting high inflation. Mr Cain has said he favors a return to the gold standard. But politics, instead of data or principles, seems to guide its views. Mr Moore now quits the president complaining that the Fed is holding back unnecessary growth. Mr Cain has repeatedly argued that the statistical agencies failed financially in an effort to increase Barack Obama's happiness.

Perhaps, if appointed, the couple would surprise Mr Trump and vote as his previous election has, in an orthodox fashion. If they act as party trojans, the biggest risk is not that an ineffective Fed will allow inflation like the 1970s to take hold. The opposite may well result if the couple returns to hawkishness when the power changes their hands. The father is rather the Fed to become a political weapon, and that America will move closer to becoming a nation in which the government's welfare is pushing it in the country as a whole.