The attack on the Fed's chairman, Jerome Powell, has correctly led to a rebuke of Donald Trump's behavior. That does not mean that the notion of central bank independence cannot be questioned, or that is necessary for either price stability or the international position of the dollar. These are just a few things that seem exaggerations that have been discussed recently. As I noted before, the return of central bank independence (rule based monetary policy), and the return of austerity, together with the critiques of tariffs (and the resurgence of free trade) have brought back the Victorian Consensus to the center of policy discussions. A terrible mistake.
But on the issue at hand, for example, Justin Wolfers suggested that inflation will accelerate as a result of the attack on Powell (and Lisa Cook, one might add). I discussed inflation here several times. There is no risk of anything even close to this kind of inflation, simply because what caused the increase in prices was, for the most part, the depreciation of the Turkish lira, and the pass-through in the US is very limited.
The graph below shows that there is a clear correlation between the two variables. Inflation in the US remains subdued (see today's BLS report, with inflation at about 2.7%, which is not that much above the target of 2%; also I still have to find someone that shows that 2% is much better than say 3% for any particular reason.)
Today, Barry Eichengreen suggested in his Financial Times column that:
Besides the issue that it is highly controversial that reducing interest rates would be highly inflationary, or that 2.7% is some sort of a problem, there is the issue of why would investors run from the dollar and cause a crash. In his view, ultimately a question of confidence. The conventional view is that a reserve currency must be backed by trust. Trust in the legal system, in the persistence of political stability, and the protection of property rights, and sound macroeconomic management. According to this perspective, actions like U.S. actions regarding Venezuela, tax cuts that increase the burden of public debt, threats to the independence of the Federal Reserve, or the rise of authoritarian politics under the Trump administration might undermine confidence in the dollar.
However, there's another view, one that I explore in a this paper, arguing that power, rather than trust, underpins reserve currency status. John Maynard Keynes famously compared money to language: the dominant currency is like the dictionary, and the one that writes the dictionary controls the language. From this standpoint, the dollar’s dominance is reinforced by U.S. geopolitical and military strength.
Barry correctly notes that the main argument against the demise of the dollar is that there is no alternative (not that TINA). He suggests that agents could run to gold, but essentially notes that gold is a bubble and that is very risky.
Neither the attack on the Fed, nor the intervention in Venezuela, to mention the two things that have been discussed the most in this eventful new year so far, would lead to inflation or a demise of the dollar. As Keynes said about Lloyd George, the leader of the Liberals, that he disliked (to put it mildly): "The difference between me and some other people, is that I oppose Mr Lloyd George when he is wrong and support him when he is right." Trump might be wrong about how he is going about changing the way we the US runs monetary policy. But on the need to reduce the rates, and the notion that central bank independence is not necessary for price stability, he might not be wrong.
PS: The rise of the dollar to hegemonic position between the collapse of the pound, the Tripartite Agreement in 1936 and Bretton Woods, occurred before the Treasury-Fed Accord of 1951 that made the Fed independent of the Treasury.
