The cynical inflation machine

Inflation does not befall us like a curse, nor does it descend on us as tragic fate. It is always the result of reckless, and sometimes criminal, policy. These words were spoken by Ludwig Erhard, the visionary German minister of economics who laid the foundations for West Germany’s Wirtschaftswunder (“economic miracle”) in the 1950s and 1960s.

Today, inflation is once again a global phenomenon. Stranger still, for decades, central banks have treated a 2 percent inflation rate as not only acceptable, but desirable. It takes a remarkably convoluted mind to explain why the quiet, permanent erosion of people’s purchasing power should be considered a public good. Yet this doctrine is still defended by many economists.

The death of price stability

The mandate of the European Central Bank is clear: to provide price stability in the eurozone. On any plain reading, deliberately targeting 2 percent inflation is already a breach of that mandate. The Federal Reserve’s mandate is more complicated, because it is responsible both for price stability and employment, goals that can easily come into conflict. But in practice, today’s central bankers no longer seem to target price stability at all. They target managed inflation. The result is the slow confiscation of citizens’ prosperity and purchasing power through a cynical technocratic game.

One common argument in favor of managed inflation is the commonplace claim that “inflation is better than deflation.” This opinion is not, however, justified. It is true that falling prices can point to a potential recession if they result from overcapacity, but this may also be a necessary correction. But there is another aspect of declining prices: the positive effect of increased productivity. This kind of “deflation” is beneficial.

Reckless government overspending makes the problem almost impossible to control.

 

Life, of course, has become more complicated. Excessive government spending is itself inflationary, and when central banks buy government bonds, they accelerate the creation of money. The Fed and the European Central Bank both do this under the name of quantitative easing. In the case of the ECB, this was a blatant violation of the rules.

Central banks have now begun raising interest rates, hoping they can regain control over inflation. But this exposes the fundamental contradiction at the heart of their policy. A central bank that openly insists on a 2 percent inflation target has already conceded that it does not believe in price stability. Price stability means zero inflation. Anything else is merely a managed decline in the value of money.

Reckless government overspending makes the problem almost impossible to control. The consequences will be severe. Inflation will create enormous social problems, and those who will suffer most are retirees and people on fixed incomes, whose payments cannot keep pace with rising prices. Future obligations are already underfunded, and inflation will make that failure impossible to hide.

Policymakers on both the monetary and fiscal sides are now experimenting with new tools. The European Central Bank and European institutions have already decided to introduce the digital euro. In the United States, policymakers want to issue stablecoins backed by U.S. Treasuries. But neither CBDCs nor stablecoins will protect citizens from inflation, nor will they solve the debt problem. As long as disproportionate public overspending continues, these instruments will serve only to camouflage the crisis in the short term.

The European Central Bank will soon need a successor to Christine Lagarde. One can only hope that Ms. Lagarde, a pure politician, will be replaced by someone who understands the institution’s mandate and takes it seriously. The Trump administration has appointed Kevin Warsh as the new head of the Federal Reserve. Mr. Warsh is comparatively hawkish on inflation and has promised a new style of central banking, which gives grounds for cautious optimism. He wants to stop the purchase of government debt.

In his statement after his first Federal Open Market Committee meeting, Mr. Warsh made a point that should be obvious, but that is widely ignored by his central-banking colleagues: “The Committee will deliver price stability.”

The fact that he needed to declare this objective is the clearest possible indictment of contemporary monetary policy.