Central banks aren’t perfect, but they work best when politicians aren’t calling the shots. That pillar of monetary policy is now under siege.
President Donald Trump continued over the weekend to try to bully his hand-picked central bank chief into slashing interest rates. Trump is begging the Federal Reserve to juice the economy, seemingly contradicting his own claim that the American economy is the “BEST IT HAS EVER BEEN!” (It’s not.)
Turkish President Recep Tayyip Erdogan took his dislike for his country’s monetary policy to the next level over the weekend, firing his central bank chief. No official reason was given for the ouster of Murat Cetinkaya, but Erdogan was frustrated by Turkey’s high interest rates, which he blamed as the cause for the nation’s high inflation. (It isn’t.)
The dramatic firing sent the Turkish lira sinking 2% against the US dollar and deepened doubts about the independence of the country’s central bank.
“Under President Erdogan, the credibility of monetary policy has been severely undermined,” said Jason Tuvey, senior emerging market economist at Capital Economics.
Central banks under assault
Turkey is the poster child for what can happen when political leaders meddle with central banks. Years of pressure from Erdogan limited the central bank’s willingness to cool off the red-hot economy by raising rates. That led to higher inflation that the central bank only belatedly tried to tackle.
“Turkey is the classic case of how efforts by politicians to take control of monetary policy have undermined the inflation-fighting credibility of central banks,” said Tuvey.
Central banks in most modern economies are designed to be insulated from the short-term whims of politicians. The goal is to give central bankers the freedom to snuff out inflation — even if that hurts political leaders at the ballot box.
In Turkey, the annual inflation rate spiked to 25% last year as the central bank, under pressure from Erdogan, failed to aggressively raise interest rates. The Turkish lira crashed to record lows and the stock market plunged.
Turkey’s new central bank chief, Murat Uysal, may launch a “large cut” of several percentage points at the next meeting, on July 25, “to appease” Erdogan, according to a research report published by Piotr Matys, Rabobank’s emerging markets foreign exchange strategist.
Matys warned that such a move would be a “major policy mistake” given the lira’s slide and suggested the reshuffling at Turkey’s central bank “could mark the end of its independence.”
Win Thin, global head of currency strategy at Brown Brothers Harriman, said the only “crime” of Turkey’s central bank governor was failing to cut rates.
“We all know who really controls monetary policy now,” Thin wrote in a note to clients.
But Erdogan’s views are unorthodox. The Turkish president has called himself the “enemy of interest rates,” which he sees as the cause of inflation.
“That’s just economic ignorance,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group.
In reality, central banks use interest rate hikes as a way to cool off overheating economies to prevent inflation from spiraling out of control.
Is Powell feeling the heat?
Trump’s own economic views have been questioned. He’s put severe pressure on Fed chief Jerome Powell to slash interest rates even though the stock market is at all-time highs, credit conditions are strong and the jobs market looks healthy.
“Our most difficult problem is not our competitors, it is the Federal Reserve,” Trump tweeted on Friday, adding that the US central bank “doesn’t have a clue.”
Boockvar said there is no way to square Trump’s call for rate cuts with his argument that the American economy is the best it’s ever been. And yet the Fed is widely expected to cut rates later this month.
For its part, the Fed has sought to ease fears that it is acting at the behest of Trump.
“The Fed is insulated from short-term political pressures,” Powell said in a speech late last month.
Powell noted that Congress purposely designed the Fed to be independent “because it had seen the damage that often arises when policy bends to short-term political interests.”
In a press conference last month, Powell also dismissed Trump’s argument that he can be demoted. “I think the law is clear that I have a four-year term, and I fully intend to serve it,” Powell told reporters.
Still, some have questioned whether the Fed really should be independent.
“Why should monetary policy, this very powerful tool to control the economy, not be subject to the democracy just like every other instrument of government?” Art Laffer, co-author of “Trumponomics: Inside the America First Plan to Revive Our Economy,” told CNBC on Monday.
Boockvar suggested that the Fed may already be feeling the heat.
“As much as the Fed and Jay Powell tell us they do what they think is right, they are still human beings and are subject to pressure,” Boockvar said. “He’s in a very tough situation when you have the president breathing down your neck.”
Perhaps a new era is beginning, one where politicians have greater say over central bank policy. But it’s hard to see how monetary policy based on political calendars, instead of economic fundamentals, will end well.