The Return of the Anguish of Central Banking: Why the Fed and Inflation Go Hand in Hand


The recent outbreak of price inflation with the jump to an annual rate of 8.6 percent in May 2022 came as a surprise to the US central bank .

Central Banks Don’t Fight Inflation

Failing to apply countermeasures in time, the Fed is now faced with the hard job of bringing down the price inflation rate without causing a recession. After having left his job in 1978, he held an alarming speech at the meeting of the International Monetary Fund in Belgrade, on September 30, 1979. His presentation bore the title «The Anguish of Central Banking.» In his talk, the former chairman of the American Federal Reserve explained why central banking and price inflation go hand in hand. In his presentation, Burns offered little hope for an escape from secular inflation.

« At any time within that period, it could have restricted money supply and created sufficient strains in the financial and industrial markets to terminate inflation with little delay. » Modern central banks lack the stamina to fight inflation in a consistent way. They may try to curb the inflationary pressure, but «by and large,» monetary policy has fallen under the spell of being «governed by the principle of under nourishing the inflationary process while still accommodating a good part of the pressures in the marketplace.» Burns explained that it is the same in other parts of the world where almost all modern central banks are functioning basically in a similar political environment, and thus behave in the same fashion leading to the «anguish of central banking» . Central banks are not only hostages of their political environment, but they are also technically and intellectually not up to their job.

« It does not provide central bankers with decision rules that are at once firm and dependable» .

Secular Price Inflation

Inflation seems to be more benign nowadays, but it is a harsh twist of words to say price stability has been achieved when, since 1980, the official price index has doubled. Central bankers still meet surprises «at practically every stage of the process of making monetary policy», and modern interventionist academic monetary theory has actually contributed very little «to provide central bankers with decision rules that are at once firm and dependable». Seen from a long-term historical perspective, we still live in an inflationary age, and the turning point for the US can be clearly defined in 1914 when the US central bank began to operate. It took only a couple of years for the newly created Federal Reserve System to finance the American entry into World War I and to create an inflationary boom in the 1920s that prepared the way for the deflationary period during the Great Depression in the 1930s.

After the Second World War, prices began their steady rise again, first slowly, then, since the early 1970s, in an accelerated way. The success of the monetary policy in 1979/1980 of dampening the inflation and wiping out inflationary expectations was mainly due to a false estimation of the future growth of the velocity of money. Paul Volcker, then chairman of the Federal Reserve, wanted to curb inflation, but he did it in this swift form largely inadvertently, by squeezing the money supply at an amount consistent with a supposedly rising velocity of money circulation. Thereby, the intended «gradualist approach» had become a much more radical monetary experiment than planned .

Incessant Debt Creation

Global debt creation has been going on at an unprecedented pace, and the major players in this game are the central banks under the obvious or implicit tutelage of their governments to whom they own their jobs. At first, central banks provide liquidity that allows debt accumulation. Then, because of the rise of the debt burden, central banks become reluctant to raise the interest rates and curb the debt expansion as they fear the negative consequences for the financial markets and their impact on the economy. Over the past decades, several situations happened when the leading central banks refrained from continuing with a restrictive policy because the stock and bond markets came under stress.

Equally problematic is the case of the European Central Bank. Led by its chairwoman, Christine Lagarde, the European Central Bank rather lets the debt growth continue and the price inflation rise than risk debt service problems of the highly indebted countries in the south of eurozone along with France. In the current institutional setting, it is the natural tendency of central banks to produce unsustainable booms first and prolong the inevitable slump in the aftermath. In this perspective, it seems an idle game to expect better central bankers or improved analytical tools, or more reliable econometric models.

Main proposals to dissolve the monopolistic structure of central banking include the «denationalization of money» and letting free banking flourish, to establish a modern gold standard or the concept of a bitcoin standard.

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