Two words that worry global central bankers the most
Around the world, what were once solid lines dividing the responsibilities of those in charge of fiscal policy and monetary policy are being challenged or redrawn. The big picture: If elected governments succeed in undermining their central banks' independence — pressuring them to suppress interest rates or monetize debt to bail out yawning public debt problems — it foretells a world of higher…
Global central bankers' chief concerns are increasingly framed by the notion of fiscal dominance, according to recent discussions at the Kansas City Federal Reserve's symposium in Jackson Hole, Wyoming. This term describes a scenario where elected governments exercise undue influence over central banks, compelling them to prioritize the fiscal needs of politicians over the maintenance of low and stable inflation.
The Bank of Japan, Prime Minister Sanae Takaichi's administration, has been under pressure to refrain from raising interest rates, despite mounting inflation. Meanwhile, the Japanese finance ministry has cooperated with the U.S. Treasury on unconventional currency market interventions to support the yen. French presidential hopeful Jean-Luc Mélenchon has even suggested canceling European Central Bank debt to alleviate fiscal burdens, potentially burdening the monetary authority with the nation's financial challenges.
In the United States, President Trump has attempted to dismiss Fed Governor Lisa Cook, and the Treasury has intervened to keep long-term borrowing costs low through bond market measures. Attempts to weaken central bank independence have not been entirely unsuccessful, as most institutions possess robust legal protections against political interference.
However, the mounting U.S. federal debt, with annual deficits ranging from 6% to 7% of GDP, even in periods of full employment, complicates the Fed's efforts to control interest rates.
IMF managing director Kristalina Georgieva emphasized that central banks' primary responsibility is to keep inflation low and stable, avoiding any temptation for monetary policy to bail out fiscal authorities. Fed Chairman Kevin Warsh cautioned that if the Fed fails to ascertain a decline in inflation, interest rates may be adjusted accordingly, contrary to the President's initial assertions.
Despite differences in debt situations and institutional specifics across advanced economies, the overarching theme remains consistent: if legislators perceive central banks as a fiscal lifeline, the risk of compromising monetary policy for fiscal gains becomes a significant concern. Former Bank of England official Adam Posen warns that while extreme circumstances like World War II or the Great Depression may warrant such actions, doing so in a typical economic environment poses substantial dangers.
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