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Administering monetary medicine

Published in Insights, The New Zealand Initiative’s newsletter, 20 September 2019

Imagine you went to your GP and received an unpleasant diagnosis. Would you want your doctor to panic in front of you, speculate that your disease might be terminal and prescribe a strong medicine? Or would you prefer your practitioner to calmly explain what she is doing and reassure you that her tried-and-tested treatment will work?

Most of us would choose the latter option. Indeed, clinical research has found that a doctor’s reassurance promotes health outcomes and healing.

With central banks, it is the same. The job of a central banker is to reassure the public even as they prescribe their medicine.

This week, the Federal Reserve delivered a masterpiece in the art of administering monetary medicine.

When Jerome Powell, the chair of the US central bank, announced a small cut in the federal funds rate, he did so calmly. He stressed that the US economy was in good shape. He also said that he would not rule out further cuts but did not think they would be needed after the one he just delivered.

Powell did what a good doctor would do with her patients. The headlines reflected the reassurance. Bloomberg summed it up as “Powell stresses solid U.S. outlook after Fed cuts rates again”.

Not everyone was happy, though. While Powell was still reading out his carefully worded statement, President Donald Trump tweeted, “Jay Powell and the Federal Reserve fail again. No “guts,” no sense, no vision! A terrible communicator!”

So, let us imagine what the Fed should have done according to Trump.

For a start, the cut would have been much deeper – at least 50 basis points. Then Powell would have drawn a dire picture of the world economy and outlined grave domestic risks. Next, he would have announced preparations for negative interest rates and quantitative easing.

Finally, Powell would have given some colourful, strongly worded media interviews. He would have called on the government and households to borrow and spend. In this way, they should help him push up inflation and perhaps also lower the exchange rate.

Although all that would have made Trump happy, consumers and businesses would have been shell-shocked. The Fed’s speculation of economic Armageddon would become self-fulfilling.

Responsible central bankers, therefore, do not behave as Trump suggests.

Just as there are good and bad governments, there are good and bad central bankers.

At least America is lucky to have a good central bank chair.

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