The European Central Bank seems to be taking its cues from the Federal Reserve, so the ECB governing council’s decision last week to keep its monetary policy accommodative is a good hint about what the Federal Open Market Committee will do—or rather, not do—at its meeting this week.
It doesn’t matter that U.S. inflation is 5%, against 2% in the eurozone, or that the Fed is buying $120 billion in bonds each month against the ECB’s increased pace of €80 billion a month, which is equivalent to about $97 billion. The ECB benchmark rate is zero and the Fed’s rate is near zero.
ECB President Christine Lagarde said the eurozone’s central bank would continue its pandemic emergency bond purchases at least until March of next year, and perhaps longer if it judges the COVID-19 crisis is not yet over.
So it seems optimistic to hope, as some apparently do, that the Fed will talk openly this week about tapering its asset purchases. Most economists expect tapering talk in the third quarter at the earliest and no action until next year.
At Wednesday's meeting, we can expect a repetition of the standard tropes—loose monetary policy will be maintained until maximum employment is reached, high inflation is just a transitory phenomenon, inflation expectations remain anchored, and we’re not ready to talk about tapering bond purchases.
But outside the Fed there is more talk about the dangers of the central bank monetizing government debt. This is supposed to be a big no-no for central banks, but the 2008 financial crisis, and now the pandemic crisis, provide cover for the Fed, ECB, and other central banks to violate this cardinal principle of not letting politicians determine monetary policy.
Technically, of course, a central bank monetizes debt only when it directly purchases government bonds. But the fig leaf of vacuuming up bonds from the secondary market—freeing Treasury bond buyers to directly buy new issues and then sell them into the secondary market—is growing so transparent it is hiding nothing.
The conservative editorial board at the Wall Street Journal last week decried the practice as it bewailed the surge in inflation. Monetizing the debt distorts price signals and capital allocation, the Journal’s editorial complained. Worse, the Fed may feel constrained to continue monetizing debt, an experiment with a vastly uncertain outcome.
Former Fed governor Kevin Warsh warned in an op-ed that monetization is like walking through a one-way door. “Talking about tapering is a sideshow, however well-publicized,” Warsh wrote last week. “What matters now is what the Fed does, not what it says.”
Michael Faulkender, economic policy chief at the Treasury Department in the latter half of the Trump administration, in an op-ed last month, recalled the 2013 warning from the Bank for International Settlement’s former general manager, Jaime Caruana, that maintaining extraordinary tools—such as debt monetization—after a crisis is passed can be damaging in its support for unsustainable fiscal practices.
“The first cost is that it masks the true debt service costs of fiscal policy,” Faulkender wrote in the Baltimore Sun.
Democratic proposals to spend another $4 trillion entail more debt, despite tax increases to help cover the cost. “Instead of allocating proposed tax receipt increases to cover existing structural deficits, they are looking to create new unfunded entitlements,” said Faulkender, who is now a finance professor at the University of Maryland.
This is not the kind of talk you will hear from Fed Chairman Jerome Powell at his press conference, nor will this be a topic in the FOMC minutes when they are released in July.
But somebody has to talk about it, and foster a public debate to counteract Fed groupthink.