Merkel for the Fed: The German leader's welcome rebuke to central bankers

Merkel for the Fed. WSJ Editorial
The German leader's welcome rebuke to central bankers.
The Wall Street Journal, page A14, Jun 04, 2009

To the Red Sox winning the World Series, we can now add another miracle for the ages: A politician demanding tighter money. We refer to German Chancellor Angela Merkel, who in a Berlin speech Tuesday rebuked the world's central bankers, notably including the U.S. Federal Reserve, for being too politically accommodating. Hallelujah, sister.

"The independence of the European Central Bank must be preserved and the things that other central banks are now doing must be retracted," Mrs. Merkel told a meeting sponsored by Germany's association of metal- and electrical-industry employers. "We must return together to an independent central-bank policy and to a policy of reason, otherwise we will be in exactly the same situation in 10 years' time." Referring to the U.S. central bank specifically, she said "I view with a great deal of skepticism the extent of the Fed's powers."

Usually when a politician lobbies a central bank, it's to demand easier money. We can't recall a similar tight-money intervention from a national leader, save perhaps Ronald Reagan's quiet support for Paul Volcker in the 1980s. Mrs. Merkel may have been channeling Ludwig Erhard, the great Chancellor whose hard-money policies helped to catapult the German economy from the ruins of World War II. Looking further back, she no doubt knows that the Weimer inflation of the 1920s paved the way for Hitler.

Whatever her inspiration, this is the second time Mrs. Merkel has volunteered to be the designated driver amid the G-20's fiscal and monetary binge. Three months ago, she led a revolt against President Obama's demand that Europe follow his Keynesian spending spree. Her spending restraint is already looking wise as the U.S. asks the world to finance a debt burden rising to World War II levels.

Now she's taking aim at monetary excess, even as the European Central Bank is being lobbied to pursue the same kind of "quantitative easing" that the U.S. Fed has carried out. The ECB is preparing to announce the details of its purchase of $85 billion in low-risk (mostly corporate) debt, and Ms. Merkel may have wanted to send a signal that it ought to stop there. She also rightly fingered "monetary policy in the United States" that was "politically supported" as a main cause of the current mess.

As it happens, Fed Chairman Ben Bernanke was asked about Mrs. Merkel's remarks yesterday during testimony on Capitol Hill. He said he "respectfully" disagreed, adding that, "The U.S. and global economies, including Germany, have faced an extraordinary combination of a financial crisis . . . plus a very serious downturn. I am comfortable with the policy actions that the Federal Reserve has taken."

We'd agree -- and maybe Ms. Merkel would too -- that the Fed clearly needed to counter the declining velocity of money amid the autumn and winter panic. We've also given Mr. Bernanke the benefit of the doubt on some of his liquidity interventions. But the Fed has since elbowed its way into fiscal policy by buying housing and other dodgy assets, and it is also directly monetizing federal debt by buying Treasurys. The latter move appears to have had the opposite of its intended effect, scaring the world's investors to bid up long-term rates for fear the Fed has sold its independence to Congress and the White House. The Fed should call a halt to such purchases at its monetary policy meeting later this month.

Notwithstanding Mr. Bernanke's "comfort" with his actions so far, the world is wondering when the Fed will start to remove the flood of money it has injected into the economy during the crisis. Mr. Bernanke says not to worry, as his mentor Alan Greenspan also did yesterday. But this is cold comfort given their earlier track record. The Fed's habit is to look at backward indicators, such as the cost-of-living index and the jobless rate, rather than at currency and commodity prices that can warn of asset bubbles and inflation ahead. This is precisely the mistake both men made in 2003, as the recently released Fed transcripts from that year illustrate. The warning that Mrs. Merkel -- and China and the financial markets -- is sounding is whether the Fed will have the political courage to start removing that liquidity even if the unemployment rate is high, and before it creates another mess.

Meanwhile, on Capitol Hill yesterday Mr. Bernanke preferred to do some fiscal policy moonlighting. "Unless we demonstrate a strong commitment to fiscal sustainability in the longer run," he said, "we will have neither financial stability nor healthy economic growth." We can see why Mr. Bernanke would want to change the subject from his own monetary responsibilities, but he'd be wiser to heed Mrs. Merkel.