Amir Yaron, the governor of the Bank of Israel, should consider himself a lucky man. All around the world his fellow central bankers are facing unprecedented pressure to toe the economic line of presidents and prime ministers. Some have found themselves out of a job.
That was the fate of Murat Cetinkaya, Turkey’s central bank chief.
Cetinkaya had been enduring what for any economic policymaker is a perfect storm of recession, inflation, and a power-hungry president who puts his political needs ahead of economy, in this case Recep Tayyip Erdogan. Cetinkaya was fired early last Saturday morning.
Jerome Powell, the chairman of the U.S. Federal Reserve, doesn’t have to worry for now about inflation or economic growth, both of which for now at least are behaving well. But he has had to face the strong and unpredictable winds of Hurricane Donald, which are enough to blow away tougher men than Powell.
For months, the Fed chief has been under pressure from Trump’s Twitter feed to cut interest rates.
"If we had a Fed that would lower interest rates, we would be like a rocket ship," Trump said on Friday, for instance. "We don't have a Fed that knows what it's doing." At one point the president even reportedly considered firing or demoting him.
Powell has bravely defended the principle of central bank independence, but slowly, slowly he has knuckled under to Trump’s thinking (if such a word applies in this case). On Wednesday, Powell all but declared that the Fed would lower interest rates later this month.
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Yaron’s boss, Prime Minister Benjamin Netanyahu, is no great respecter of institutions and is happy to change the rules to make sure he gets his way. If he faces an indictment, then he’ll pass legislation giving immunity to the prime minister. If the High Court threatens to declare the new law unconstitutional, no problem, he’ll get legislation barring it from vetoing laws. If he can’t form a coalition, then call elections; if the poll looks bad, he’ll call them off.
Fortunately for Yaron, Bibi is preoccupied with the legal system. The economy is humming along nicely and presents no threat to his remaining in office. But Netanyahu’s disrespect for institutions, which he shares with much of the political right, is setting the stage for the day when the Bank of Israel could find itself under the same kind of pressure as the central banks in the U.S. and Turkey.
The problem for central bankers
Will that end badly? The conventional answer is that it has to. In the modern era, central banks have been granted an unusual degree of independence because without it, economic policy would be entirely in the hands of politicians whose horizon extends no further than the next election cycle.
Erdogan’s firing of his chief central banker caused the Turkish lira to plunge and will likely drive out the last of those brave foreign investors still putting their money in Turkey. Powell’s remarks sent Wall Street into ecstasy, but that’s because the stock market has become addicted to low interest rates and worries only about how it can get its next fix.
If Powell acts on his promise, he’ll be adding more fuel to an economy that is already in overdrive. That can only end badly, or so holds the consensus view.
The problem central bankers face when defending their independence is that they aren’t quite as confident as before that they have a complete grasp of what makes economies tick, and should be left alone by ignorant and mercurial politicians to get on with their work.
The Great Recession of 2008-2009 and the years that have followed have seen a lot of the rules of monetary policy go out the window. One of the most basic is that low unemployment will cause wages to rise and stoke inflation. Interest rates should move up or down to manage this phenomenon.
Yet the jobless rate in America and many other countries is at a record low, wage growth has been modest and inflation is almost non-existent.
As Janet Yellin said not long before Trump showed her the door and brought in Powell to lead the Fed: “Our framework for understanding inflation dynamics could be mis-specified in some fundamental way.”
When Erdogan opines that high interest rates cause inflation, rather than contain it as conventional economics says, it’s easy to laugh him off. When Trump says the Fed’s rate of 2.25% to 2.5% is choking economic growth, it’s not as easy to dismiss it as so much politically motivated nonsense.
Maybe in today’s economy the new norm for interest rates is much lower than in the past.
Economists and central bankers don’t know, but give them this much credit, at least they’re trying to find out. The politicians who want to make their central banks subservient don’t have any better insights, they just want to party till Election Day.
Not surprisingly, the leaders who are harassing their central bankers are often populists who take the view that all government (the courts, the civil service and central banks, to name a few) should follow the dictates of elected officials. The principle is that whoever wins an election is master of the universe.
These populists dislike institutions, rules and expertise, but they offer no viable substitute. Unfortunately, the Americans and Turks cheering on Trump and Erdogan will soon learn that painful lesson.