The Return of the Anguish of Central Banking: Why the Fed and Inflation Go Hand in Hand
(The following text is a revised update of an article that was first published in 2005.)
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 (the Federal Reserve). Having ignored the warnings of the Austrian school economists, the policy makers were paralyzed in the face of a phenomenon they deemed impossible to happen. None of their forecasting models had triggered an inflation alert.
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. Prolonged stagflation may characterize the next decade. Are we back in the 1970s? During the stagflation at that time, Arthur Burns was the chairman of the Federal Reserve. 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. Current worldwide philosophical and political trends, Burns diagnosed, would continue to undermine wealth creation. These modern cultural trends spilled over to politics, produced permanent budget deficits, and introduced “a strong inflationary bias” (p. 13) into the economy.
Reviewing central bank action in the 1960s and 1970s, Burns stated in his speech that “viewed in the abstract, the Federal Reserve System had the power to abort the inflation at its incipient stage fifteen years ago or at any later point, and it has the power to end it today. 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. It did not do so because the Federal Reserve was itself caught up in the philosophic and political currents that were transforming American life and culture” (p. 15).
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” (p. 16).
Central banks are not only hostages of their political environment, but they are also technically and intellectually not up to their job. Central bankers make errors and encounter surprises “at practically every stage of the process of making monetary policy” (p. 18); misinterpretations of statistics abound, and there is also no reliable scientific guide for central banking: “Monetary theory is a controversial area. It does not provide central bankers with decision rules that are at once firm and dependable” (p. 17).
Burns ended his speech by saying:
My conclusion that it is illusory to expect central banks to put an end to the inflation that now afflicts the industrial democracies does not mean that central banks are incapable of stabilizing actions; it simply me
Article from Mises Wire