The US Federal Reserve (Fed) has delivered what it announced: the turnaround in monetary policy. Down to the last detail, the decisions to stabilize the balance sheet total by the middle of next year were unsurprising – a sign of good communication in advance. The European Central Bank (ECB) will normalize monetary policy in December, but has a further way to go than the Fed. But that fits in with the fact that Europe is lagging behind the US in the economic cycle.
When the central banks normalize monetary policy, it will be time to free them of political burdens – especially unsolved distribution problems. In the pandemic, fiscal and monetary policymakers have probably worked together better than ever to at least absorb the economic fallout from the epidemic that has now cost millions of lives.
The fact that higher prices remained in the end is anything but surprising after such a catastrophe. It has little to do with politically or monetarily homemade inflation.
In the future, however, the interests of the central banks and the government will be less aligned. Perhaps even less than in the period of notoriously low inflation between the great financial crisis over ten years ago and the pandemic. It is all the more important to separate the two areas cleanly. Above all, it is important that democratically legitimized politics do not offload tasks to the central banks that they cannot deal with themselves.
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MMT in the end
Problems like this almost always involve distribution issues. The great financial crisis was already largely triggered by this: In the USA, lax lending for poorer households replaced a solid social policy – the corresponding loans later almost brought the world financial system to collapse. The system had to be kept alive with a flood of money from the central banks. The attempt to get out of this mode was then interrupted by Corona.
Today it is again about distribution problems. The US government under President Joe Biden is trying to create social equilibrium with huge spending packages. The theory known as Modern Monetary Theory (MMT) is particularly popular with left-wing Democrats, whose supporters tend to think that anyone who disagrees with them is stupid.
Basically, MMT boils down to letting the central bank finance expenditure through purchases of government bonds. As long as inflation does not rise, so the theory goes, the state can borrow virtually indefinitely. It’s just a shame that the rate of inflation is rising significantly, especially in the USA, and that’s also because of the generous financial policy.
MMT hits the wall faster than expected. The “Economist” rightly wrote that the USA can probably never finance a social system based on the European model without VAT – one could generally say: without a broad tax base. Conclusion: The Fed is the wrong address, the inequality must be remedied by the politicians.
It doesn’t work without financial equalization
In Europe, on the other hand, the tensions between individual euro countries are in the foreground. As a single economic area, Euroland has strong and weak regions. Many factors are decisive for this, the geographical location alone: Greece, southern Italy and Portugal are far from the center of the market and do not belong to the rich regions.
Such inequalities can only be overcome in the long term – and this is far too little understood and accepted – only through financial transfers. The question is not if, but how they happen. In markets with different currencies, this works through the devaluation of weak currencies.
In a market with a single currency, it runs through monetary policy, or directly and democratically legitimized through open financial equalization. If nothing works, a haircut is inevitably the solution, which also amounts to a transfer.
Often these are the same voices who want to block political solutions to distribution conflicts and who complain afterwards when they end up with monetary politicians. Regardless of how their mandate is defined in detail, the central banks are de facto responsible for the stability of prices, the economy as a whole and the financial system; all three are also connected. Because of this, they cannot ignore problems that are left to them. You shouldn’t expect too much from them.
More: Why Isabel Schnabel would be a good Bundesbank president