Tag: monetary policy

Should the State mandate or advise?

It depends of course. But in America, which was established to empower each individual to make their own decisions, the state should only regulate those individual activities that might harm others such as violating property rights. This attitude presumes that each of us cares more about our wellbeing than does anyone else and know better how to achieve it taking account of our differences in tastes, interests, and risk preferences. It has resulted in a society of more prosperous and happier members.

This can be contrasted with the view that the average person is not intelligent enough or self-motivated enough to maximize their potential and needs to be guided by smarter, wiser people.

A society in which each individual enjoys the maximum freedom of choice hardly means that the government has little or no role in our wellbeing. In addition to providing public safety, shared institutional and physical infrastructure development, and the adjudication and enforcement of contracts (the rule of law), government can contribute to the provision of the knowledge to help inform the individual choices we each make. I want to review two very different areas of government involvement that have reflected the above conflicting attitudes of the government’s best role—monetary policy and public health policy.

Section 8 of the US Constitution gives the federal government the power “To coin Money, regulate the Value thereof,…” Our twelve Federal Reserve Banks and the Board of Governors of the Federal Reserve System carry out that mandate via a system of market determined prices of goods and services and an inflation target of 2%. While I would prefer a monetary policy in which currency was issued or redeemed at a fix price for a hard anchor (traditionally gold) in response to market demand (currency board rules), the Fed has behaved very well within its inflation targeting regime over the past two years (after keeping its policy interest rate too low until two years ago).

A successful inflation targeting policy requires keeping inflation expectations anchored to the target (2% in the US) so that economic wage and price decisions are made in light of that expectation. But todays’ policy actions are only fully felt over the next year or two (what Milton Friedman called “long and variable lags” in the effects of policy). Federal Reserve policy is implemented largely by setting the rate at which it supplies the money it creates to the market. If it sets that rate below the so called neutral rate, it must supply money to keep the rate low. If it sets the Fed Funds (and related) rate above the neutral rate, it must absorb money from the market to keep the rate high. Setting its policy interest rate is the lever by which it controls the rate at which the money supply grows. Each Federal Reserve President and Governor must evaluate all available information about economic activity most likely over the next one to two years and determine in like of that what monetary growth is most likely to result in 2 percent inflation over that period. If market participants believe that the Fed’s choice is most likely to result in achieving the stated target in the future, their wage and price decisions will anticipate that inflation and thus bring it about.

It should be obvious that if Fed officials are honest it attempting to achieve their target and explain as fully as they themselves understand the prospects to the public and the public has confidence in the Fed’s commitment, this is the best that can be done. In fact, the Fed deserves high marks for such transparency in our uncertain and evolving world. Each person and firm make their own forward looking decisions in light of their best guesses of future conditions. The Fed’s guidance is the best and most the Fed can do to bring or keep inflation on target.  

When governments don’t trust “the people” to make their own decisions (they are not smart enough or are two lazy or whatever), they must mandate the “proper” behavior. Consider our approach to the public’s health during the Covid pandemic. Whether government should offer advice and provide information on what is known about a disease such as Covid-19 is complicated by the fact that we should not be free to expose others to communicable diseases. In the case of Covid the government’s understanding of its nature and best protection grew and evolved over time. But the US public heath agencies lost credibility from the beginning by telling well intentioned lies.

“In early March 2020, Dr. Fauci said ‘there’s no reason to be walking around with a mask.’ In the same interview he said people could wear masks if they liked, but they wouldn’t get perfect protection, and it would further pinch what at the time was a short supply of masks for doctors and nurses.” PolitiFact | Marco Rubio says Anthony Fauci lied about masks. Fauci didn’t.

But more to my point, CDC officials thought that their shut down and isolation mandates would be more effective than allowing individuals to determine how best to protect themselves and others. The subsequent evidence suggested that they were wrong. Any benefits were outweighed by very substantial costs. Read the following articles and studies for examples.

Scott Atlas on Lies

“I explore the association between the severity of lockdown policies in the first half of 2020 and mortality rates. Using two indices from the Blavatnik Centre’s COVID-19 policy measures and comparing weekly mortality rates from 24 European countries in the first halves of 2017–2020, addressing policy endogeneity in two different ways, and taking timing into account, I find no clear association between lockdown policies and mortality development.” https://academic.oup.com/cesifo/article/67/3/318/6199605?login=false  

“The most restrictive nonpharmaceutical interventions (NPIs) for controlling the spread of COVID-19 are mandatory stay-at-home and business closures. The most restrictive nonpharmaceutical interventions (NPIs) for controlling the spread of COVID-19 are mandatory stay-at-home and business closures. Given the consequences of these policies, it is important to assess their effects. We evaluate the effects on epidemic case growth of more restrictive NPIs (mrNPIs), above and beyond those of less-restrictive NPIs (lrNPIs)….

“After subtracting the epidemic and lrNPI effects, we find no clear, significant beneficial effect of mrNPIs on case growth in any country…. While small benefits cannot be excluded, we do not find significant benefits on case growth of more restrictive NPIs. Similar reductions in case growth may be achievable with less-restrictive interventions.”  January 2021 study

Worrying About Mandates and Lockdowns as Delta Variant Hits Unvaccinated Californians

Econ 101: Erdogan’s Turkey

President Erdogan believes that by cutting interest rates on the Turkish lira the resulting depreciation of its exchange rate will cheapen Turkish goods and thus increase their exports and promote growth (the China model, he thinks). Accordingly, he has replaced four central bank governors who could not bring themselves to accede to his demands. “Revolving door-Turkeys-last-four-central-bank-chiefs”

In an earlier disastrous cycle, the Central Bank of Turkey (CBT) reduced its policy rate from 24% in 2019 in steps to 8.5% in mid 2020 only to raise it again to 19% in March 2021 until the latest cuts started in September of this years. In November, “The Monetary Policy Committee (MPC) has decided to reduce the policy rate (one-week repo auction rate) from 15 percent to 14 percent.” “Press Releases/2021/ANO2021-59”  

When I was part of the IMF team in 2000-1 working with the Turkish authorities to regain control of inflation (which ranged from 60 and 100 percent between 1980 and 1999) and clean up the banking sector (they closed 13 banks in 2000), the CBT policy interest rate was briefly raised to 100% (ala Paul Volcker in the US). Inflation declined rapidly to single digit levels (until the last four years) with interest rates quickly following.

The dollar price of the Turkish lira has fallen in half since February of this year (i.e., a dollar will buy twice as many lira–one lira cost 0.14 dollars in February and 0.061 dollar on December 17).  Erdogan seems to think he is choosing to benefit workers (exporters) over consumers (importer), though they are generally the same people.  If the lira depreciates, the rest of the world can buy lira more cheaply and thus (according to Erdogan) will buy more cheaper Turkish exports. This should increase the demand for Turkish good and the jobs that produce them and increase the growth of the Turkish economy.

As any economist can explain to Mr. Erdogan, depreciating the exchange rate with lower interest rates in Turkey than in the rest of the world is achieved by printing more money with which to buy foreign currencies. Broad money (M2) increased almost 48% in November 2020 from a year earlier and 24% from a year earlier this November. But such a rapid increase in the money supply will increase prices in Turkey over and above the increase in the price of imports from the lira’s depreciation. “Turkey-central bank-Erdogan”

Inflation in Turkey has risen from single digits between 2004 to 2016 to “21.3%” in November 2021 (annual rate from a year earlier). According to the Central Banking Journal “Official figures show Turkish inflation reached 21.31% year-on-year in November, but there is considerable controversy over whether these figures are accurate. Several well-informed observers, have told Central Banking that they believe the official figures understate actual inflation.”  “Turkey’s currency hits new low after further rate cut”  Steve Hanke reports the actual rate at around 100%  “Steve Hanke’s estimate of Turkey’s inflation rate”

In short, Mr. Erdogan’s crazy policy of reducing interest rates has not made Turkish goods cheaper for the rest of the world. As the lira became cheaper for foreigners (depreciation), the lira price of those goods became more expensive (inflation). The real effective exchange rate (which takes account of both) is not being significantly reduced because Turkey is experiencing higher and higher inflation along with the lira’s depreciation. Monetary policy works in Turkey the same way as in every other place.  The CBT’s inflation target, by the way, is 5%. “Turkey-Erdogan currency crisis”

Judy Shelton’s monetary policy

I share Judy Shelton’s support for monetary policy with a hard anchor. Following currency board rules, the public should determine the money supply they want to hold at its fixed price. Historically, gold was the most common hard anchor. It worked well for centuries. However, it had two problems.

The first is that central banks actually bought and stored gold, which distorted its market supply and thus price. Widespread adoption of a gold anchor combined with central banks buying up much of it would be an even more serious problem today. But gold can anchor the price of a currency without the central bank actually hoarding gold. It would instead issue its currency against other safe assets, such as government debt securities, as fixed gold price. It would fully back its currency with such assets so that it could redeem it all if the public chose to return it. This would ensure that the gold price in the market in the central banks currency was always very close to its official (anchor) price.

This system of indirect redeemability, as Leland Yeager called it, would ensure a more stable market price for gold relative to other goods and services and thus a more stable purchasing power of a currency fixed to it. However, choosing a single commodity as the anchor (its second problem) would result in a less stable value of the currency than would choosing a small basket of widely traded commodities. https://www.adamsmith.org/blog/returning-to-currencies-with-hard-anchors

Given the discretion to manage their currency supplies, central banks have historically tended to undermine its value as the result of over issuing it (inflation). Judy is right to want to limit that discretion. The Federal Reserve Act mandates that the Federal Reserve should aim for price stability (and full employment). This is an important constraint on the Fed’s behavior, but we can do better.

Covid-19: What should Uncle Sam do?

On February 29 the first person in the United States died from Covid-19, the disease caused by SARS-CoV-2, the so-called novel coronavirus first observed in Wuhan, China.  On March 12, three more people succumbed from this disease bringing the total to 41. Ten days later on March 22, 117 died bringing the total to 419 as the exponential growth of Covid-19 deaths continues. Globally 15,420 had died by midday March 23 and deaths are rising fast.

How and where will this end?  Shutting the economy down and keeping everyone isolated in place until the virus “dies” for lack of new victims would ultimately kill everyone from starvation (if not boredom).  This pandemic will only end (stabilize with the status of the flu, which currently kills about 34,000 per year in the U.S.) when an effective vaccine is developed and administered to almost everyone. This will take one year to eighteen months if it is discovered today, and that is if we are lucky that the safety and effectiveness trials go according to plan. Without a vaccine, the pandemic will “end” when most of us have acquired immunity to it as a result of having and surviving (as almost everyone will) covid-19 –acquiring so called herd immunity.  This assumes that having and surviving the disease will immunize us. This is generally the case with viruses but has not yet been established for SARS-CoV-2.

Our hospitals and medical services could not handle the patient load if every one contracted this disease over too short a period, so it is important to slow down the pace of infection–so called flattening the curve (which could spike quickly as you see from the opening paragraph). The ideal strategy is to allow the infection of those with low risk of serious illness or death to speed up herd immunity with minimum demand on our limited health facilities, while protecting and treating the most vulnerable. The young and healthy are least vulnerable and the old and health-impaired are the most vulnerable.  We should reopen schools and restaurants after Easter and gradually restart our cultural entertainment lives adhering to higher standards of hygiene and public interaction. This would be ideal both with regard to speeding up herd immunity and with regard to minimizing that damage to the economy.

What should government do?

I am from the government and I am here to help (it is risky to attempt humor in these times, but what the hell). “Treasury Secretary Steven Mnuchin warned GOP senators that the unemployment rate could spike to nearly 20 percent if they fail to act dramatically…. The United States is expected to lose 4.6 million travel-related jobs this year as the coronavirus outbreak levies an $809 billion blow to the economy, according to a projection released yesterday by the U.S. Travel Association…. Research from Imperial College London, endorsed by the U.K. government, suggests that 2.2 million would die in the United States and 510,000 would die in Britain if nothing is done by governments and individuals to stop the pandemic.” “six-chilling-estimates-underscore-danger-of-coronavirus-to-public-health-and-the-economy”

“Infectious disease experts do not yet know exactly how contagious or deadly the novel coronavirus is. But compared to SARS and MERS, SARS-CoV-2 [as the novel coronavirus is now labeled] has spread strikingly fast: While the MERS outbreak took about two and a half years to infect 1,000 people, and SARS took roughly four months, the novel coronavirus reached that figure in just 48 days.”  “Mapping the Novel Coronavirus Outbreak”

The U.S. does not have the medical equipment or hospital beds that will be needed for those anticipated to need ICU facilities.  And as poorly equipped medical staff fall ill from their exposure to the Coronavirus, we will run out of enough doctors and nurses to care for them forcing us to default to the unpleasant realities of medical triage where doctors begin to assess and choose those that have a higher probability of survival and to leave the weakest to fend for themselves. This has already started in Italy.

So, what should the government do? Its response might be considered under three categories:  a) Stop or slow the spread of covid-19; b) Help state and local health service providers care for those needing it; and c) minimize the damage to the economy (i.e. to those whose income is affected by the disease or the measures taken to slow the spread of the disease).

As with all good policies, as the government determines its immediate approaches to the crisis, it should keep one eye on the longer run implications of the policies adopted. It should balance the most effective immediate actions with the minimization of what economists call moral hazard in the future.  The simplest and best-known example of moral hazard results from the now hopefully banished practice of governments bailing out banks when they fail as a way of protecting depositors. This one way bet for the banks–they profit when they win their bets and the government bails them out when they lose them–encouraged banks to take on excessive risks. In the U.S. we have replace bank bail outs with deposit insurance and efficient bank resolution (bankruptcy) procedures. “Key Issues in Failed Bank Resolution”

If economists do nothing else, we pay very close attention to incentives, particularly those created by government rules and regulations (including taxes and subsidies).  Government financial assistance must also be carefully designed to be temporary, recognizing the danger that expansions of government into the economy in emergencies have the bad habit of becoming permanent.

From these general considerations our response should be guided by these principles: Measures should be effective with the least cost. They should be narrowly targeted. They should be temporary. The cost of financial assistance should be shared by all involved–no bailouts.

Flatten the curve 

The government’s first priorities must be to slow the spread of covid-19 while supporting the medical needs of those contracting it.  Limiting the number of infected will limit the resulting deaths (guesstimated to be around 1% of those infected by this virus). Slowing the rate at which people are infected–flattening the curve–will reduce the peak demand for hospital beds and related services until a vaccine is found (once one or several candidates are discovered today, it will take 12 to 18 months of tests to establish its safety and effectiveness and manufacture enough to start administering it).

Despite clear warnings that the novel coronavirus posed serious threats to the U.S. for which we were not prepared, President Trump failed to act until very recently, calling the scare a Democratic plot as recently as February 28. “Trump-says-the-coronavirus-is-the-democrats-new-hoax”  “U.S. intelligence agencies were issuing ominous, classified warnings in January and February about the global danger posed by the coronavirus while President Trump and lawmakers played down the threat and failed to take action that might have slowed the spread of the pathogen, according to U.S. officials familiar with spy agency reporting.” “US-intelligence-reports-from-january-and-february-warned-about-a-likely-pandemic”

Countries that acted quickly to identify and isolate those infected by the virus have generally succeeding in slowing its spread without shutting their economies down.  South Korea, Singapore, and Taiwan have tested widely and quarantined those testing positive, many of whom were asymptomatic. Their economies have not been shut down. Restaurants and bars remain open as do schools in Singapore and Taiwan.  New cases in S Korea have fallen to very low levels two weeks ago and active cases have been declining since March 11 as more people recover than acquire the disease. On March 22 only two people died from the disease.  Cases and deaths have remained low in Japan, Singapore and Taiwan. The following describes the lesson’s from Singapore’s success: plan ahead, respond quickly, test a lot, quarantine the sick, communicate honestly with the public, live normally:  “Why-Singapore’s-coronavirus-response-worked–and-what-we-can-all-learn”

As a result of the U.S. failing to act earlier, the potential for this approach has been reduced in the U.S.  Nonetheless, the government should urgently remove its barriers to testing, increase the supply of tests, and pay most of the cost of testing. In order to discourage frivolous testing those being tested should pay a small amount of the cost (e.g. ten dollars per test).  Even today (March 21) very few Americans are tested despite frantic catch up efforts by the U.S. government.  “A-government-monopoly-led-to-botched-covid-19-test-kits-but-private-labs-are-now-saving-the-day” Positive test results (“cases”) in the U.S. are rising rapidly (983 new cases on March 16 jumped to 9,339 on March 22, for a total of 33,546). However, as so little testing has been possible, there is no way we can know whether this dramatic increase reflects increases in infection or only the increase in the identification of existing infections. “Peggy Noonan gets tested–finally”

As a result, the government has urged people to stay home, and most entertainment centers (theaters, cinemas, restaurants, gyms, and bars) have closed, and a few state governors are mandating it.  Many international flights have been cancelled.  Aside from grocery stores and pharmacies, most shops and malls have closed. A controversy is raging over whether closing schools does more harm than good. Among the arguments against it is that because serious illness and death among the young is rare but they can spread the disease (to their families at home and others), attempting to block their infection interferes with herd immunization (protection from infection as the result of a large proportion of the population becoming immune as the result of recovery from infection).

The economic impact of those drastic measures will be explored below, but the government must now urgently prepare for the surge of covid-19 patients promising to overwhelm our brave medical health care workers, medical supplies and hospital beds even with these draconian measures. Priorities must be given to properly equipping medical service providers and training their replacements as they fall ill. Hospital beds and respirators and other equipment needed for the more seriously ill must be urgently produced, in part by turning out and away, less seriously ill patients and those with non-emergency, elective treatments. We can delay the investigation into why these steps where not taken two months ago when the need was identified.

Care for the sick

The government should support the market’s natural incentives to develop better treatments and ultimately a vaccine (i.e. profit). This raises challenging policy issues. Protecting the patent rights of firms developing treatments protects the profit incentive for them to do so. However, the sharing of research findings, thus threatening such patents, can greatly accelerate the discovery of helpful medicines or procedures. Hopefully rights can be established and protected that both encourage drug development and cooperative information sharing.

The failure of the U.S. government to provide for or allow significant testing for covid-19 is a scandal. The government should get out of the way. “Coronavirus-and-big-government” Its claim last week and the week before that testing was opening up is sadly not true.  By March 19th the U.S. with a population of 327 million had only tested 103,945 people (0.03%).  S. Korea with a population of 51.5 mil. had tested 316,664 by March 20th (0.6%) and Germany with a population of 82.9 mil. had tested 167,000 by March 15th (0.2%)  “Covid-19-why-arent-we-prepared”

President Trump’s trade war has damaged world’s ability to fight covid-19 in general but more specifically his tariffs on medical supplies are contributing to their shortage in the U.S.  “The US-China trade war has forced US buyers to reduce purchases of medical supplies from China and seek alternative sources. US imports of Chinese medical products covered by the Trump administration’s 25 percent tariffs dropped by 16 percent in 2019 compared with two years earlier.”  “Tariffs-disrupted-medical-supplies-critical-us-coronavirus-fight”

Save the economy

Having missed the opportunity to flatten the curve via testing and targeted quarantines, the U.S. has taken much more drastic steps to restrict public interactions, shutting down the entertainment, educational, and transportation sectors of the economy. These should result in temporary interruptions of the supply of these services that will bounce back when the restrictions are lifted. Some output will be lost forever (lost classroom time, and restaurant meals) but others can be recouped or at least restored to original levels (rates). Clothing and other retail items not purchased during the shut down can be purchased later.

What the economy will look like afterward (hopefully only a few months) will depend on several factors. The first is the extent to which our public behavior is altered permanently. Home movies might permanently replace some part of our usual attendance to the cinema. Teleconferencing might permanently reduce meeting travel or accelerate the existing trend in that direction, etc.

The policies being debated in congress at this moment for protecting individuals and firms from the financial cost of the temporary shutdown can profoundly affect the future composition and condition of the economy. Every big firm out there is working on how they can tap some of the taxpayer’s money that government will be giving out. Those pushing government interventions into new areas on a permanent basis will exploit the occasion to slip in their favorite policies. Unfortunately, once the government moves into an area– it rarely withdraws. Almost 19 years later, the horrible Patriot Act, adopted when a scared public was willing to trade off liberty for security, is still largely with us.

Our public interest would be served by incentives that lead those who might be sick with covid-19 to stay home rather than risk infecting others, and by policies that enable viable firms that lost customers and individuals who stayed home to bridge their financial gap until returning to normal. Affected firms and individuals will continue to have expenses (food, rent, mortgages, etc.) but no incomes. They should be provided with the funds to meet these expenses in order to return to life/work when the lights go back on. The sharing of the cost of those funds must be considered politically fair and must incentivize the desired behavior. Everyone must have some skin in the game (a share of the cost). Adopting measure that fill those criteria will not be easy.

The government (taxpayers) should cover much of the cost of the covid-19 related medical services and hospital costs, including very widespread testing. Medical service providers should be tested daily (e.g., several doctors have died from covid-19 in Italy). Anyone staying at home and testing positive should receive sick leave paid for by the government.

Assistance to companies and the self-employed should be as targeted as possible on those forced to reduce or stop operations as a result of covid-19. Where possible, assistance should take the form of loans to companies that continue to pay wages to their employees even if not working. Restrictions should be placed on how such loans are used (no stock buy backs, or salary increases during the life of the loans). Bank and lending regulators should allow and in fact encourage temporary loan forbearance by the lenders on temporary arrears from otherwise viable firms. “Bailout-stimulus-rescue-check” One small businessman convincingly argued that wage subsidies that keep working on the payroll are better than generous unemployment insurance, which makes it easier for firms to lay off their workers. “Dear-congress-i’m-a-small-business-owner-heres-what-my-business-needs-to-survive”

What about the big companies, such as Boeing, the airlines, the Hotel Chains, and Cruise ship operators? Yes, they should be included in the loan forbearance and incentive loan programs, but they should receive no special consideration beyond that. If government (partially) guaranteed loans through banks to pay wages and other fixed expenses for a few months are not enough to finance a firm’s expenses without income for a few months it is probably not viable in the long run anyway and should be resolved through bankruptcy as were GM and Chrysler in earlier financial crises. This would wipe out the stakes of owners while preserving the ability of the firm to return to profitable operation with new owners. “Bailing-out-well-if-bail-out-we-must”

Monetary policy

The American economy (and elsewhere) is suffering in the first instance a supply shock (sick people unable to work and produce). This fall in income from supply disruptions also reduces demand. Cutting the Fed’s already low interest rate target to almost zero is a mistake. No one will undertake new or expanded investments because of it, and its impact on reducing the return on pensions and other savings will, if anything, reduce spending. The last decade of very low interest rate policy targets has already contributed to excessive corporate debt and inflated stock prices (recently deflated back to normal).

Injecting liquidity via new lending facilities and international swap lines, as the Fed is now undertaking, is the correct response. If lenders allow their borrowers to delay repayments for a few months, they need to replace that missing income somehow (rather than calling in nonperforming loans and bankrupting the borrower). The Federal reserve should substitute for that income by lending to banks freely against the good collateral of government debt or government guaranteed debt.

“The vital need of everyone in the economy, from the corner drugstore to the local transit authority to the mightiest multinational, is liquidity: credit to meet payroll and other key obligations so as to remain solvent until the end of what we all must hope is a finite crisis.”  “Here’s-an-economic-aid-plan-better-than-mitch-McConnell’s”

Macroeconomic policy

As noted above, the government’s help should be narrowly targeted to the direct victims of covid-19.  A general fiscal or monetary stimulus is not needed or desirable.  Nonetheless, it will add to the federal debt that is already bloated by years of annual deficits at the peak of a business cycle when a surprise is customary and appropriate.

“The United States is not confronted with a financial crisis and a follow-on crisis of demand, as in 2008 or 1929. Rather, previously robust consumption and production are being deliberately halted to save lives. Thus, traditional tools of monetary and fiscal stimulus, such as zero interest rates and direct cash aid to households, are unlikely to prove decisive. You can’t shop, or invest in new construction, while on lockdown.”  “Here’s-an-economic-aid-plan-better-than-mitch-McConnell’s”

This is a dangerous period both for our personal health and for the health of the economy. Affected firms should be helped in order for them to continue paying their employees and to remain solvent until they can return to production. But the United States has failed to prepare properly and is handling the fight against covid-19 poorly. We need to reopen our schools and restaurants and return to normal at a reasonable pace while allowing herd immunity to develop at a faster pace while supporting the most rapid development of a vaccine possible. Don’t fight this wildfire with our eyes shut while enhancing the dangers of future fires from ill-advised measures undertaken in this emergency environment.

Stay strong everyone. We will all get through this.

Paul Volcker, RIP

Paul Volcker was a man of strong convictions, including a commitment to sound money https://wcoats.blog/2017/10/14/sound-money/.  It surprises me that in 1971 he urged President Nixon to end the United States’ commitment to maintaining the price of gold to which most countries had fixed the exchange rates of their currencies. However, he led the Federal Reserve in ending the inflation that followed.

I first met Paul Volcker while seconded by the International Monetary Fund to the Board of Governors of the Federal Reserve in Washington. During that year (1979) I reported to my former U of Chicago classmate, David Lindsey, while working with another UC classmate, Tom Simpson, in the Capital Markets Department in the Research and Statistics Division (it’s a small world).

At the time Mr. Volcker was President of the Federal Reserve Bank of New York. The New York Fed conducted the monetary operations for the entire system (open market operations buying and selling government securities with Federal Reserve member banks–all of whom had offices in New York). Thus, the FRBNY was the most important and powerful of the twelve Federal Reserve Bank making the Board of Governors in Washington a bit jealous. NY Fed President Volcker had recently taken some decision with regard to “offshore” banking located in New York. The Board of Governors in Washington thought that Volcker had not properly consulted them, so they ordered him to come to Washington and explain himself (and get slapped on the wrists).  My boss, David Lindsey, allowed me to attend that board meeting, sitting quietly at the back of the room.

Cigar smoking Volcker stands 6’7”.  G. William Miller, Chairman of the Board of Governors at that time was a nonsmoker standing something like 5’6”.  Miller had banned smoking in the Board Room during his tenure, driving smoking governors like Nancy Teeters nuts.  Ms. Teeters was the first female Governor on the Board of Governors. The image of the diminutive Miller trying to dress down the towering Paul Volcker is seared into my memory.

As luck would have it (for Ms. Teeters and for the nation), Paul return a few months later (Aug 6, 1979) to replace Miller as Chairman, cigar in hand. Smoking, and firm monetary policy had returned to the Board of Governors. I was again privileged to sit at the back of the Board room on several more occasions.

Paul immediately changed how monetary policy was conducted. He reigned in the rate of growth of the money supply, focusing on Net Borrowed Reserves rather than the federal funds rate, which shot up to almost 20% for a few months.  Inflation had risen from around 4% when Nixon closed the gold window unevenly to almost 15% (percent increase from a year earlier) in April 1980 before plunging to 2.5% in Aug 1983. It took nerves of steel to allow short term interest rates to climb to almost 20% before turning inflation around.

Is Trump killing his own re-election?

The Fed (Federal Open Market Committee) is meeting this week to review and set or reset monetary policy.  I don’t know whether it should increase its policy rate, leave it the same or reduce it. https://www.adamsmith.org/blog/returning-to-currencies-with-hard-anchors  The market expects a one quarter percent reduction in the rate.  President Trump is quoted yesterday as saying it should be reduced more than that. WSJ: the confusing Fed

There are several problems with Trump’s statement. One is that if the Fed reduces the rate, its claim to be reacting to the data and its mandate is undercut by the President’s interference. Is the Fed doing what seems best or responding to political pressure?

But if the U.S. economy is heading South, as it may be, it is probably because of the damaging effects on the U.S. and world economies of Trump’s trade wars with almost everyone but especially with China. Trump’s tariffs have imposed significant costs on the American consumers who pay them with higher prices for targeted imports. More importantly, his trade wars have injected significant uncertainty into the continued viability of the global supply chains that have helped lower costs here and abroad and increased world output.  Their retrenchment is lowering world income and pushing many economies, including potentially the U.S. economy into recession. A U.S. recession a year from now will seriously damage Trump’s chances of reelection.

Trump’s wars on trade seem to be motivated by his mistaken belief that the U.S. trade deficit with China, Germany and others reflects unfair trade practices on their part. His misuse of a national security concern to impose protectionist tariffs and restrictions on foreign competitors (protecting inefficient U.S. industries we would be better off allowing competition to shrink) seems motivated by vote buying. https://wcoats.blog/2018/09/28/trade-protection-and-corruption/  The result is a reduction in our income and potentially his electoral defeat. Our trade deficits largely reflect the use of the U.S. dollar in international reserves (which require a deficit to supply them) and our large and growing fiscal deficits (much of which is being financed by China and other trade surplus countries). Trump’s abandonment of government spending restraint is the cause of those twin deficits https://nationalinterest.org/feature/who-pays-uncle-sams-deficits-26417

It’s not that we don’t have real issues with some of China’s trade related practices, but Trump’s approach to addressing them is not productive. Rather than working with the EU and Japan and others who share our concerns to confront China together, he is attacking all of them with threats of more tariffs. Rather than strengthening the WTO, he is weakening it. Rather than using the Trans Pacific Partnership (a significant advance in modern trade agreements) to encourage China to adopt its rules, Trump withdrew the U.S. from the agreement– a huge mistake. The real question is how much more damage will Trump inflict on the world economy before he surrenders and declares victory or is voted out of office. https://wcoats.blog/2019/06/07/the-sources-of-prosperity/

Modern Monetary Theory—A Critique

So called Modern Monetary Theory (MMT) has become popular with Green New Dealers because it claims to remove or at least loosen traditional constraints on government spending.  MMT offers unconventional ideas about the origins of money, how money is created today, and the role of fiscal policy in the creation of money. It argues that government can spend more freely by borrowing or printing money than is claimed by conventional monetary theory. “The most provocative claim of the theory is that government deficits don’t matter in themselves for countries—such as the U.S.—that borrow in their own currencies….  The core tenets of MMT, and the closest it gets to a theory, are that the economy and inflation should be managed through fiscal policy, not monetary policy, and that government should put the unemployed to work.” James Mackintosh,  “What  Modern Monetary Theory Gets Right and Wrong’  WSJ April 2, 2019.

In fact, despite its efforts to change how we conceive and view monetary and fiscal policies, MMT abandons market based countercyclical monetary and fiscal policies for targeted central control over the allocation of resources. It would rely on specific interventions to address “road blocks” upon the foundation of a government guaranteed employment program.

MMT is an unsuccessful attempt to convince us that we can finance the Green New Deal and a federal job guarantee painlessly by printing money. But it remains true that shifting our limited resources from the private to the public sector should be judged by whether society is made better off by such shifts.  Printing money does not produce free lunches.

Where does money come from?

It has been almost 50 years since the U.S. dollar (or any other currency for that matter) has been redeemable for gold or any other commodity whose market value thus determined the value of money. It remains true, however, that money’s value depends on its supply given its demand. The supply of money these days reflects the decisions of the Federal Reserve and other central banks.

The traditional story for the fractional reserve banking world we live in is that a central bank issues base or high-powered money (its currency and reserve deposits of banks with the central bank) that is generally given the status of “legal tender.”  You must pay your taxes with this money.  We deposit some of that currency in a bank, which provides the bank with money it can lend. When the bank lends it, it deposits the loan in the borrower’s deposit account with her bank, thus creating more money for the bank to lend.  This famous money multiplier has resulted in a money supply much larger than the base money issued by the central bank. In July 2008, base money (M0) in the United States was $847 billion dollars while the currency component of that plus the public’s demand deposits in banks (M1) was almost twice that — $1,442 billion dollars. Including the public’s time and savings deposits and checkable money market mutual funds (M2) the amount was $7,730 billion.  [I am reporting data from just before the financial crisis in 2008 because after that the Federal Reserve began to pay interest on bank reserve deposits at the Fed in order to encourage them to keep the funds at the Fed rather than lending them and thus multiplying deposits. This greatly increased and distorted the ratio of base money to total money, i.e. reduced the multiplier. In October 2015 at the peak of base money M0 = $4,060 billion, of which only $1,322 billion was currency in circulation.]

The neo Chartalists, now known as MMTists, want us to look at this process differently.  In their view banks create deposits by lending rather than having to receive deposits before they can lend.  While a bank loan (an asset of the bank) is extended by crediting the borrower’s deposit account with the bank (a liability of the bank), the newly created deposit will almost immediately be withdrawn to pay for whatever it was borrowed for.  Thus, the willingness of banks to lend must depend on their expectations of being able to finance their loans from existing or new deposits, by borrowing in the interbank or money markets, or by the repayment of previous loans at an interest rate less than the rate on its loans.

The money multiplier version of this story assumes a reserve constraint, i.e., it assumes that the central bank fixes the supply of base money and bank lending and deposit creation adjust to that.  The MMT version reflects the fact that monetary policy these days targets interest rates leaving base money to be determined by the market.  Traditionally the Fed set a target for the over-night interbank lending rate—the so-called Fed Funds rate.  In order to maintain its target interest rate, the central bank lends or otherwise supplies to the market whatever amount of base money is needed to cover private bank funding needs at that rate.  The market determination of the money supply at a given central bank interest rate is, in fact, similar to the way in which the market determines the money supply under currency board rules under which the central bank passively supplies whatever amount of money the market wants at the fixed official price (exchange rate) of the currency.  With the Federal Reserve’s introduction of interest on bank reserve deposits at Federal Reserve Banks, including excess reserves (the so-called Interest On Excess Reserves – IOER), banks’ management of their funding needs for a given policy rate now involve drawing down or increasing their excess reserves.

According to MMT proponents, loans create deposits and repayment of loans destroys deposits.  This is a different description of the same process described by the money multiplier story, which focuses on the central bank’s control of reserves and base money rather than interest rates. It is wrong to insist that deposits are only created by bank lending and equally wrong to insist that banks can only lend after they receive deposits.

How is Base Money Produced?

MMT applies the same approach to the creation of base or high-powered money (HPM) by the government as it does to the creation of bank deposits by the private sector:

“It also has to be true that the State must spend or lend its HPM into existence before banks, firms, or households can get hold of coins, paper notes, or bank reserves…. The issuer of the currency must supply it first before the users of the currency (banks for clearing, households and firms for purchases and tax payments) have it. That makes it clear that government cannot sit and wait for tax receipts before it can spend—no more than the issuers of bank deposits (banks) can sit and wait for deposits before they lend.”[1]

This unnecessarily provocative way of presenting the fact that government spending injects its money into the economy and tax payments and t-bond sales withdraws it does not offer the free lunch for government spending that MMT wants us to believe is there. Central banks can finance government spending by purchasing government debt, but this does not give the Treasury carte blanche to spend without concern about taxes and deficit finance.  This is the core of MMT that we must examine carefully.

MMT claims that:

“(i) the government is not constrained in its spending by its ability to acquire HPM since the spending creates HPM….  Spending does not require previous tax revenues and indeed it is previous spending or loans to the private sector that provide the funds to pay taxes or purchase bonds….

“(iii) the government deficit did not crowd out the private sector’s financial resources but instead raised its net financial wealth.

“Regarding (iii), the private sector’s net financial wealth has been increased by the amount of the deficit. That is, the different sequencing of the Treasury’s debt operations does not change the fact that deficits add net financial assets rather than “crowding out” private sector financial resources.”[2]

MMT is correct that federal government spending does creates money. But what if the resulting increase in money exceeds the public’s demand (thus reducing interest rates), or the destruction of money resulting from tax payments or public purchases of government debt reduces money below the public’s demand (thus increasing interest rates)?  MMT claims to be aware of the risk of inflation and committed to stable prices (an inflation target) but ignore it most of the time.

If the central bank sets its policy interest rate below the market equilibrium rate, it will supply base money at a rate that stimulates aggregate demand. If it persists in holding short term interest rates below the equilibrium rate it will eventually fuel inflation, which will put upward pressure on nominal interest rates requiring ever increasing injections of base money until the value of money collapses (hyperinflation). If instead the central bank money’s price is fixed to a quantity of something (as it was under the gold standard, or better still a basket of commodities) and is issued according to currency board rules (the central bank will issue or redeem any amount demanded by the market at the fix price), arbitrage will adjust the supply so as to keep the market price and the official price approximately the same (for a detailed explanation see my: “Real SDR Currency Board”).  Unlike an interest rate target, a quantity price target is stable.

Does the Story Matter?

But does the MMT story of how money is created open the door for government to spend more freely and without taxation, either by borrowing in the market or directly from the central bank?  According to MMT, “One of the main contributions of Modern Money Theory (MMT) has been to explain why monetarily sovereign governments have a very flexible policy space that is unencumbered by hard financial constraints.  Not only can they issue their own currency to meet commitments denominated in their own unit of account, but also any self-imposed constraint on their budgetary operations can be by-passed by changing rules.”[3]

MMT maintains that: “Politicians need to reject the urge to ask ‘How are we going to pay for it?’…   We must give up our obsession with trying to ‘pay for’ everything with new revenue or spending cuts….  Once we understand that money is a legal and social tool, no longer beholden to the false scarcity of the gold standard, we can focus on what matters most: the best use of natural and human resources to meet current social needs and to sustainably increase our productive capacity to improve living standards for future generations.”[4]

MMT proclaims that a government that can borrow in its own currency “has an unlimited capacity to pay for the things it wishes to purchase and to fulfill promised future payments, and has an unlimited ability to provide funds to the other sectors. Thus, insolvency and bankruptcy of this government is not possible. It can always pay….  All these institutional and theoretical elements are summarized by saying that monetarily sovereign governments are always solvent, and can afford to buy anything for sale in their domestic unit of account even though they may face inflationary and political constraints.”[5] But inflating away the real value of obligations (government debt) is economically a default.  Moreover, debt cannot grow without limit without debt service costs absorbing the government’s entire budget and even the inflation tax has its hyperinflation limit (abandonment of a worthless currency).

MMT advocates do acknowledge that at some point idle resources will be used up and that this process would then become inflationary, but this caveat is generally ignored.  But if MMT is serious about an inflation constraint, we must wonder about their criticism of asking how government spending will be paid for.  In this regard MMT is a throwback to the old Keynesianism, which implicitly assumed a world of perpetual unemployment.

Is There a Free Lunch?

MMT states that when the government spends more than its income (and thus must borrow or print money) private sector wealth is increased “because spending to the private sector is greater than taxes drawn from the private sector, the private sector’s net financial wealth has increased.”  As explained below this deficit spending increases the private sector’s holdings of government securities, but not necessarily its net financial wealth.

Whether we take account of the future tax liabilities created by this debt in the public’s assessment of its net wealth (Ricardian equivalence) or not, we must ask where the public found the resources with which it bought the debt. Did it substitute T-bonds for corporate bonds, i.e. did the government’s debt (or monetary) financing of government spending crowd out private investment thus leaving private sector wealth unchanged, or did it come from reduced private consumption, i.e. increased private saving. Any impact on private consumption will depend on what government spent its money on.  MMT claims that “the government deficit did not crowd out the private sector’s financial resources but instead raised its net financial wealth,” is simply asserted and is unsupported.  Whether the shift in resources from the private sector to the public sector is beneficial depends on whether the value of the government’s resulting output is greater than is the reduced private sector output that financed it.

One way or another, government spending means that the government is commanding resources that were previously commanded by or could be commanded by the private sector.  If the government takes resources by spending newly created money that the central bank does not take back, prices will rise to lower its real value back to what the public wants to hold. This is the economic equivalent of the government defaulting on its debt, contrary to MMT’s claim that default is impossible.  This inflation tax is generally considered the worst of all taxes because it falls disproportionately on the poor.  In fact, MMT proponents rarely mention or acknowledge the distinction between real and nominal values that are, or should be, central to discussions of monetary policy. The exception to the inflationary impact of monetary finance is if the resources taken by the government were idle, i.e. unemployed, which, obviously, is the world MMT thinks it is in.

MMT claims to have exposed greater fiscal space than is suggested by conventional analysis. They claim that government can more freely spend to fight global warming or to fund guaranteed jobs or other such projects by printing (electronic) money. However, the market mechanism they offer for preventing such money from being inflationary (market response to an interest rate target that replaces unwanted money with government debt), implies that such spending must be paid for with tax revenue or borrowing from the public.  Both, in fact all three financing options (taxation, borrowing, and printing money), shift real resources from the private sector to the public sector and only make society better off if the value of the resulting output is greater than that of the reduced private sector output. There is nothing new here.

Fiscal Policy as Monetary Policy

Government spending increases M and the payment of taxes reduces it.  MMT wants to use taxation to manage the money supply rather than for government financing purposes.  MMT wants to shift the management of monetary policy from the central bank to the finance ministry (Treasury).  The relevant question is whether this way of thinking about and characterizing monetary and fiscal policy produces a more insightful and useful approach to formulating fiscal policy.  Does it justify shifting the responsibly for monetary policy from the central bank to the Finance Ministry?  Should taxes be levied so as to regulate the money supply rather than finance the government (though it would do that as well)?

In advocating this change, MMT ignores the traditional arguments that have favored the use of central bank monetary policy over fiscal policy (beyond automatic stabilizers) for stabilization purposes.  None of the challenges of the use of fiscal policy as a countercyclical tool (timing, what the money is spent for, etc.) established with traditional analysis have been neutralized by the MMT vision and claim of extra fiscal space.  In fact, as we will see below, despite their advocacy of fiscal over monetary policy for maintaining price stability, MMT supporters have little interest in and no clear approach to doing so as they prefer to centrally manage wages and prices in conjunction with a guaranteed employment program.

But the arguments against MMT are stronger than that. The existing arrangements around the globe (central banks that independently execute price stability mandates and governments that determine the nature and level of government spending and its financing) are designed to protect monetary stability from the inflation bias of politicians with shorter policy horizons (the time inconsistence problem). The universal separation of responsibilities for monetary policy and for fiscal policy to a central bank and a finance ministry are meant to align decision making with the authority responsible for the results of its decisions (price stability for monetary policy and welfare enhancing levels and distribution of government spending and its financing).  It is the sad historical experience of excessive reliance on monetary finance and the costly undermining of the value of currencies that resulted that have led to the world-wide movement to central bank independence.  MMT is silent on this history and its lessons.  As pointed out by Larry Summers in an oped highly critical of MMT, the world’s experience with monetary finance has not been good. Modern Monetary Theory-a-foolish-pursuit-for-democrats

The establishment of central bank operational independence in recent decades is rightly considered a major accomplishment.  MMT advocates bring great enthusiasm for more government spending—especially on their guaranteed employment and green projects, which will need to be justified on their own merits.  MMT’s way of viewing money and monetary policy adds nothing to the arguments for or against these policies.

The Bottom Line

To a large extent, most of the above arguments by MMT are a waste of our time as MMT advocates actually reject the macro fine tuning of traditional Keynesian analysis. “This approach of government intervention aims at avoiding direct intervention to achieve the goal (e.g. hiring to achieve full employment, or price controls to achieve low inflation), but rather using indirect “tools” while letting market participants push the economy toward desired goals by tweaking their incentives.  MMT does not agree with this approach. The government should be directly involved continuously over the cycle, by putting in place structural macroeconomic programs that directly manage the labor force, pricing mechanisms, and investment projects, and constantly monitoring financial developments….  But MMT goes beyond full employment policy as it also promotes capital controls for open economies, credit controls, and socialization of investment. Wage rates and interest rate management are also important.”[6]  No wonder Congresswomen Alexandria Ocasio-Cortez is excited by MMT.

MMT attempts, unsuccessfully in my opinion, to repackage and resurrect the empirically and theoretically discredited Keynesian policies of the 1960s and 70s.  A 2019 survey of leading economists showed a unanimous rejection of modern monetary theory’s assertions that “Countries that borrow in their own currency should not worry about government deficits because they can always create money to finance their debt” and “Countries that borrow in their own currency can finance as much real government spending as they want by creating money.” http://www.igmchicago.org/surveys/modern-monetary-theory  Both the excitement and motivation for MMT seem to reflect the desire to promote a political agenda, without the hard analysis of its pros and cons—its costs and benefits.

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[1] Fullwiler, Scott, Stephanie Kelton & L. Randall Wray (2012), ‘Modern Money Theory: A Response to Critics’, in Modern Monetary Theory: A Debate,  Modern Monetary Theory: A Debate, http://www.peri.umass.edu/fileadmin/pdf/working_papers/working_papers_251-300/WP279.pdf,  2012, page 19

[2] Ibid. page 22-23.

[3] Tymoigne and Wray, 2013 http://www.levyinstitute.org/publications/modern-money-theory-101

[4] Stephanie Kelton, Andres Bernal, and Greg Carlock, “We Can Pay For A Green New Deal” https://www.huffpost.com/entry/opinion-green-new-deal cost_n_5c0042b2e4b027f1097bda5b  11/30/2018

[5] Tymoigne and Wray, op cit. p. 2 and 5

[6] Ibid. pp. 44-45.

Their Turkey and Ours

“Recep Tayyip Erdogan believes high interest rates are the cause of inflation, not the remedy for it”  The Economist May 19, 2018 “How-turkey-fell-from-investment-darling-to-junk-rated-emerging-market”

During the 1990s the inflation rate in Turkey averaged around 80% per annum varying between 60% and 105%.  Over that period interest rates on its 3-month treasury bills averaged about 30% above the inflation rate reaching almost 150% in 1996.  The economy grew rapidly in real terms with real GDP growth averaging 8% per annum between 1995-7.  But growth depended heavily on borrowing abroad in foreign currencies.  Banks were poorly regulated, and heavily exposed to foreign exchange risk and to government debt.  Obviously, Turkey’s nominal exchange rate depreciated at about the same rate as its inflation rate in order to preserve a stable real exchange rate.

In the wake of the Asian and Russian debt crises in 1997 and 1998 foreign investors became more risk averse and capital inflows into Turkey were reduced sharply slowing down economic growth from 7.5% in 1997 to 2.5% in 1998.  A serious earthquake in Turkey’s industrial heartland in August 1999 further deteriorated Turkey’s economic performance.  The combined impact of the two pushed the economy into a deep recession, shrinking GDP by 3.6% in 1999.

With support from the International Monetary Fund (IMF) in 1999-2003 the Turkish government reigned in its spending and monetary growth and reduced its inflation rate to 10% by 2004. I was a member of the IMF’s Turkey team at that time and remember the long sleepless nights very well. Turkey’s interest rates followed inflation down and, in fact, its real interest rates (nominal interest rate minus its inflation rate) fell from 30% to negative rates as the economy stabilized. During this transition, a number of state owned enterprises were privatized, 18 insolvent banks were intervened, and debt and the financial sector were restructured and strengthened.  Within a few (rough) years the economy was growing rapidly with low inflation and low interest rates.  In 2017 real GDP grew 7.0% though inflation had crept back up to 11.1%.

Following Turkey’s and the rest of the world’s recession in 2009 the country reverted back to its bad old ways.  “Recep Tayyip Erdogan signed a decree easing access to foreign-exchange loans for Turkish companies.  The new rules lifted restrictions that barred companies without revenue in hard currencies from doing such borrowing—as long as the loans exceeded $5 million.”  How Erdogan’s push for endless growth brought Turkey to the Brink

Erdogan observed the low interest rates, low inflation, and high growth and apparently concluded that low interest rates caused low inflation rather than the other way around. Every economist knows that interest rates incorporate the market’s expectation of inflation over the period of a loan in order to establish a market clearing real rate of interest.  In 1996 when a borrower was willing to pay 130% interest and a lender was not willing to accept less it was because they expected 80% to 90% inflation per annum over the life of the loan.  The very high real rate (130% – 80% = 50%) reflects the risk premium of getting it wrong.

Central banks can, if inflation expectations adjust slowly, push real rates down temporarily by lowering nominal market rates below their equilibrium rate.  Doing so, however, increases the rate at which the money supply grows eventually increasing inflation and forcing nominal interest rates higher than they would otherwise have been.

Under political pressure from Erdogan, the central bank of Turkey has kept interest rates lower (and thus money supply growth greater) than are consistent with its inflation target of 5%.  In the last few years inflation has drifted up reaching 11.1% in 2017.  Markets have grown uneasy about the economic situation in Turkey and when the Central Bank failed to increase its policy interest rate last month from 17.75% investors began selling off Turkish bonds and withdrawing funds from the country.  Its exchange rate plummeted.  From January of this year the Turkish lira depreciated from 11.7 per dollar to 16 lira/USD at the beginning of July and to 21 lira/USD on the 22ndof August. Erdogan’s wrong-headed misunderstanding of the role of interest rates is pushing Turkey over the precipice of bankruptcy.

Meanwhile here in the United States, President Trump apparently attended the same school as Erdogan. After breaking a several decades old protocol against commenting on or interfering with the Federal Reserve’s monetary policy when he stated last month that he didn’t want to see the Fed increase its policy interest rate, he did it again a few days ago. “Trump-escalates-attacks-federal-reserve”  Trump’s advice is wrong. The Federal Reserve needs to continue raising its policy rate back toward normal levels (3% to 4%) before inflation momentum becomes any stronger. Real interest rates are still negative (less than the inflation rate).  The Fed should have started increasing rates several years earlier.

Trump and interest rates

There seems to be no norm or conventional wisdom that President Trump is not willing to overturn. Following Fed Chairman Powell’s congressional testimony Tuesday in which he confirmed the Fed’s intention to continue its gradual increase in its policy interest rate, Trump said: “I don’t like all of this work that we’re putting into the economy and then I see rates going up.”  The statement is wrong on multiple accounts.

The economy is now fully employed and interest rates probably should have been returned to normal some time ago.  The alarming current and projected fiscal deficits of the federal government will force interest rates and trade deficits still higher.  This is Trump’s fault– not Powell’s.  “Who pays uncle Sam’s deficits?”  The major policies threatening to undermine the economic boost from tax and regulatory reforms are Trump’s trade policies (pulling out of the Trans Pacific Partnership, stalling and threatening U.S. withdrawal from NAFTA, Steel and Aluminum tariffs (taxes) on our friends in Canada, Mexico and the EU, and a deepening trade war with China).  Leaving the TPP  Resisting the interest rate increases needed to keep inflation at 2% would increase the most regressive tax around (inflation).

But Presidential interference in implementing monetary policy, as is now being undertaken by President Erdoğan in Turkey, violates a long established principle and practice of central bank independence.  Historically, inflation, which falls heaviest on the poor and undermines economic efficiency and growth, has resulted primarily from governments turning to their central banks for financing in misguided and ultimately futile efforts to keep interest rates (government borrowing costs) low.

President Trump can save the economic benefits of his tax and regulatory reforms by rejoining the TPP, rapidly concluding amendments to NAFTA that improve productive efficiency and fairness, dropping the steel and aluminum tariffs, ending the trade war with China, joining with the EU, Canada, Japan and others to bring China into compliance with the rules of a strengthened WTO, and establishing a fiscal budget surplus primarily through entitlement reform.