Monetary Policy In America Is A Mess. Things Are Even Worse In Europe.

Fed chief William McChesney Martin had no appetite or political basis to embark on a collision course with the Johnson administration, and anyway, he espoused the view that his institution was “independent within the government” not “independent of government.” The dollar was ostensibly ailing, as illustrated by a rising free price of gold from spring 1968 and the DM revaluation of the following year.

The high consumer price inflation scenario for the US which many have in mind now for the years ahead is unlikely to feature economic miracles outside the US as in the 1960s. Plausibly, a key part of the story could be sustained private sector economic strength, which calls for much higher rates and which the Fed cannot deliver.

A growth cycle downturn or even recession in 2022/23 might interrupt the journey for some time to this destination. But when high CPI inflation eventually emerges, opposition to higher conventional taxation or cutting public expenditure is likely to be strong. Also, with so much corporate and mortgage debt outstanding, howls would be tremendous against any remedial monetary action which would mean higher interest rates. Hence the Fed may well settle for “kicking the can down the road.”

That conclusion, though, is not certain. There are alternative less likely scenarios where forces opposed to such cynicism could win the political majority, and the Fed has plenty of technical scope to “normalize” monetary conditions. As an illustration, the Fed could liquidate Its vast portfolio of Treasury securities over a short period as part of an operation to restore the monetary base to an effective anchor role.

It is quite different in Europe. There, “it is too late to go back” is a phrase whose infamy goes all the way back to Emperor Franz-Josef’s refusal in late July 1914 to soften Vienna’s ultimatum to Belgrade. A century-plus later, it will almost certainly be too late to go back with respect to the degraded euro. Whenever the European economy gets into a sustained recovery track out of the pandemic, the ECB will not allow rates to rise in line with any incipient rise of consumer price inflation. 

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