The end of independent central banks

David Marsh speaks to Der Spiegel

Germany needs a Macron figure, able to communicate the benefits of the euro area, as its next chancellor. David Marsh, chairman of OMFIF, explains why as well as his fears over central bank independence, the return of inflation and why the euro area still needs to change in an interview with Der Spiegel.

Der Spiegel: Mr Marsh, the US Federal Reserve has just said goodbye to its inflation target and is now tolerating inflation rates above 2%. The European Central Bank could soon follow suit. Will inflation soon be making a comeback?

Marsh: I wouldn’t be so defeatist, but it is clear that a new era is dawning. The Fed is further constraining the ECB’s freedom of manoeuvre.

Der Spiegel: How so?

Marsh: The Fed has always been careful to keep inflation and unemployment under control with its monetary policy. That is now over. Because of the pandemic, unemployment has risen sharply, and at the same time, inflation has been very low for ten years. There are reasons for this, but they have nothing to do with the central banks.

Der Spiegel: What are the reasons?

Marsh: People are getting older and saving more. Digitalisation is covering companies’ capital requirements. Globalisation has brought millions of new people into the labour market, which has driven down wages. All of this has put the brakes on inflation. From now on, fighting inflation is no longer the Fed’s most important goal. And we also have very low inflation rates in Europe.

Der Spiegel: If inflation is no longer a problem, why is the Fed’s decision to tolerate higher consumer prices such a big deal?

Marsh: Because inflation is not dead, but can once again become a real danger given the debt-financed government spending deployed in the fight against the pandemic. The central banks should be ready to fight rising inflation rates. But they are abandoning the fight.

Der Spiegel: How much inflation are we actually talking about? There are some who believe the global economy is heading back to the hyperinflation of the 1920s.

Marsh: I think that’s completely exaggerated. If industry recovers from the corona shock, prices could rise by well over 2%. That would be just fine for politicians, because if prices rise, nominal GDP also grows. And as long as that increases faster than the debt, the sovereign debt level will melt away essentially automatically.

Der Spiegel: Which would be great for finance ministers…

Marsh: …but would be accompanied by social injustice. Those who own their own homes or stock portfolios are happy because both become worth more with inflation. But those who have hardly any assets and live in rented accommodation feel rising prices much more directly. The gap grows bigger, which in turn helps the populists. We see this happening already.

Der Spiegel: Critics say that the basket of goods and services used by the ECB to measure the inflation rate, which in turn is the basis of its monetary policy, is calculated incorrectly. Do you agree with that criticism?

Marsh: I think so, yes. The real inflation is higher. As I said, real estate prices, including rents, are decisive for the cost of living and the shopping basket does not reflect that. But that is not the real problem.

Der Spiegel: What is?

Marsh: The politicisation of the central banks. The new Fed strategy is the strongest sign that central banks are taking on more and more tasks for which politicians are responsible, such as fighting unemployment. The ECB, which wants to present its new strategy in 2021, will follow in the Fed’s footsteps. We are witnessing the end of independent central banks – which was partly a myth anyway.

Der Spiegel: They were never completely independent.

Marsh: Ever since the Fed announcement, this myth has been shattered. The central banks are more politicised than they have been for decades. In Japan, this has been the case for a long time. In Europe, French President Emmanuel Macron set an example in this respect by cleverly taking Chancellor Angela Merkel by surprise and making Christine Lagarde president of the ECB.

Der Spiegel: So we have a situation in which inflation is higher than the official figure, which central banks tolerate – first tacitly, but now officially. And that is done as a way to support nation states? The accusation of central banks providing state financing is one of the harshest that can be made.

Marsh: It is more complex than that. In general, it is quite right that central banks support goals set by politics. But they must not lose the ability to do the opposite when necessary, for example when inflation rises. Central banks must not allow governments to use inflation as a weapon against debt.

Der Spiegel: Did Fed Chair Jerome Powell cave in to Donald Trump? The president had been tweeting for quite some time that the Fed should ease the reins to allow more growth.

Marsh: On the one hand, Powell has adjusted strategy to reality. At the same time, the colossal public pressure that Trump has been exerting has had an effect. When Trump summoned him to the White House at the beginning of 2019, Powell should have said, ‘Get my secretary to give you an appointment, but not for six months’. Of course, he didn’t do that.

Der Spiegel: Monetary policy is never static, like politics in general. Powell’s successor can change the strategy again if inflation rises too much.

Marsh: And he will. And that will be easier for the Fed than for the ECB – a huge problem.

Der Spiegel: Why?

Marsh: Because euro area member states are growing at radically different speeds. Germany could tolerate inflation rates of 3% to 4%, if only to reduce its export surplus. But that would be practically be the death knell for Italian competitiveness. The euro area does not have a finance minister or an economics minister because there is no political union. This is the birth defect of monetary union.

Der Spiegel: ECB President Lagarde is urging euro area member states to spend more money because the ECB is not omnipotent. Was that overdue?

Marsh: Yes, the monetary policy of the ECB was too lax for a long time, the fiscal policy of the euro area member states, especially Germany’s, too strict. Fortunately, this has changed owing to the corona shock. The European Union’s recovery fund goes in the right direction. It’s just as well that we British, the eternal naysayers, have departed. We would probably have prevented the fund from being established.

Der Spiegel: Is it not dangerous for governments to fund their aid programs with money generated by bonds the ECB buys on the market?

Marsh: It is. Germany is very sensitive to this type of public financing. This endangers the cohesion of the euro area.

Der Spiegel: What should the ECB do?

Marsh: Announce in a sensitive yet decisive way that it will stop buying government bonds from mid-2021 if the economy has significantly recovered by then and if there is no further wave of infection. It urgently needs to signal that it is considering monetary policy normalisation. Then, it can also be more flexible with regard to the inflation target. It must not give finance ministers the impression that it is always there for them. It was right for Lagarde to go all out in the pandemic. But in terms of political cohesion in the euro area, the ECB must take into account the wishes of countries like Germany.

Der Spiegel: If the ECB stops buying government bonds in the market, two things would happen: Bond prices would fall and interest rates would rise. It would be much more expensive for highly indebted countries like Italy, France and Spain to incur new debt. The alternative would be drastic austerity programs. That is something Macron will have to prevent if he wants to be re-elected in the next presidential elections in 2022.

Marsh: Despite difficulties from the Fed’s decision, the ECB must implement its own strategy, with subtlety and understanding. Otherwise it runs the risk of being made the scapegoat for everything that goes wrong.

Der Spiegel: Isn’t it already too late?

Marsh: Not yet. That would only be the case if it buys government bonds directly from governments, or if the majority of central bank heads were ex-finance ministers like Lagarde. That is why it is so important to see who will succeed Yves Mersch of Luxembourg in the six-member ECB Executive Board at the end of 2020. If it were a politician, that would cross a red line.

Der Spiegel: Do you think that the ECB will be an issue in the 2021 election campaign, for example with regard to low interest rates and the German obsession with savings accounts?

Marsh: I don’t think so. Social cohesion in Germany is not working as well as it used to, because of the gap between the well-off and the less well-off. But compared to many other countries, the Germans are doing just fine. The outcry in Germany against the ECB’s bond purchases has been limited.

Der Spiegel: Will the euro area survive?

Marsh: The error of not establishing a political union must be corrected. There are only two ways to get out of this impasse: Either the monetary union shrinks. Or it changes into a transfer union, for which the Germans in particular have to pay – with the danger of overreaching themselves. One of these two extreme options will prevail, probably the transfer union. Simply muddling through no longer works.

Der Spiegel: The Germans benefit most from the euro area as an export market. Why should they overreach themselves?

Marsh: If it were so clear that the net effect is positive, then everything would be fine. But as so often, it depends more on perception than on reality. The next chancellor will have to take responsibility for this. It would need a chancellor with outstanding communication skills who can convey the benefits of the euro area to the populace. Ever since Helmut Schmidt, Germany has not had such a politician. What is needed is a German Macron, but no matter how far and wide I look, I don’t see one coming.

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