Commentary: The biggest risk to the Fed and European Central Bank
The danger, shared by other central banks, comes from their prominence over the past few years as they have sought to combat low inflation and foster recovery in crisis-stricken economies. The monetary masters have held sway through extraordinary measures such as negative interest rates and QE. That has left them exposed to a political backlash.
Politicians on both sides of the Atlantic have been taking pot-shots at the architects of policies that shrivel the interest income of savers while buffing up the rich through higher stock markets. In the closing stages of his campaign, U.S. President Donald Trump chided the Fed for keeping interest rates so low. British Prime Minister Theresa May took a side-swipe at the Bank of England for the “bad side-effects” of its emergency policies since the financial crisis. In Germany, where thrifty citizens are irate about negligible interest on their savings, Finance Minister Wolfgang Schäuble partially blamed the ECB’s ultra-loose policies for the rise of the insurgent right-wing party, Alternative for Germany.
Such political strong-arming should be less of a worry for the Fed since it ended its third QE program in October 2014 and has gradually been raising interest rates since the end of 2015. Although its balance sheet remains swollen with total assets of $4.5 trillion, up from $900 billion a decade ago, the Fed is the only main central bank to have started normalizing monetary policy.
In practice the Fed faces two looming political threats. One is new legislation to clip its wings. It currently has full discretion over how to meet its dual mandate to achieve stable prices and maximum employment. Republican critics in Congress dislike that autonomy. They want to curtail it by making the Fed pursue a rule that would require them to set rates according to criteria that include, for example, how much spare capacity there is in the economy. If it deviated from the rule it would have to explain itself to Congress.
Such a proposal will most likely remain on the drawing board because it would be unworkable. In a January speech Fed Chair Janet Yellen argued that this type of policy rule would result in much higher interest rates. The economy is too complex and underlying conditions change too much for such a blunt approach to make sense.
A second threat to the Fed is more plausible since it requires only a politically driven personnel change at the top. There are currently two vacancies on the Fed’s governing body, the seven-strong Board of Governors, who are nominated by the president and confirmed by the Senate. In early April Daniel Tarullo, the governor who has pushed through tougher banking regulations, leaves, creating a third vacancy.
The Board’s chair and vice-chair are appointed in a similar way for four years. Yellen’s current term as chair expires in early 2018 and since Trump accused her during the campaign of being “political,” she is likely to go. Vice-chair Stanley Fischer’s term ends in the middle of next year and he is also likely to be replaced.
This gives Trump an opportunity to reshape the Fed more to his liking. Despite his criticism of the Fed for low interest rates during his campaign, his experience as a real estate developer suggests that he will back easy-money candidates rather than hawks. That’s even more likely since tighter monetary policy will strengthen the dollar, working against Trump’s hopes to improve America’s trading performance. Trump can also put forward a candidate for the new and as yet unfilled position of vice-chair for supervision who will be softer on financial regulation than Tarullo has been.
The ECB‘s executive board is more stable. Mario Draghi’s eight-year term as president lasts until October 2019. But the central bank’s governing council is fractured by mounting tensions between countries such as Germany, for which policy is too lax, and others such as Italy, for which it remains appropriate. German politicians are stepping up their attacks on the central bank’s ultra-loose policies; Schäuble called on March 9 for “a timely start to the exit”. Draghi, who indicated last Thursday that the ECB was unlikely to ease policies further, is under increasing pressure to set out a path towards more normal monetary policy.
Both the Fed and the ECB have faced exceptional challenges in combating the crises in their respective regions. Both have been bold in responding to them. But by tearing up the rule book and extending the reach of monetary policy, they have put in political jeopardy their most precious asset of all, their independence.