Politics Limits the Anti-Inflation Effort of Central Banks

THE marriage between money and politics is always stormy, but it is especially rocky at present. Over the long haul, political oversight of interest rates and money growth is bound to increase. For the immediate future, major changes in policy are not likely. In the United States, Alan Greenspan, chairman of the Federal Reserve Board, is under fire in Washington for prolonging the recession and on Wall Street for caving in to political pressure and risking a new inflation. President Bush is taking plenty of time to decide whether Mr. Greenspan will get another four-year term. Chances are he will, but Mr. Bush will likely delay his decision until close to the Aug. 6 deadline.

In Germany, Karl Otto Pohl, president of the Bundesbank (the German central bank), resigned recently in the midst of a long-running controversy over the conduct of monetary policy in the unified Europe of the 1990s.

Mr. Pohl's sudden departure reflected deep tensions in German society over the long-range cost of reunification with the former East Germany. Greatly oversimplified, Pohl wanted more autonomy and less accountability for the Bundesbank than German Chancellor Helmut Kohl - or any other leading European politician - would grant.

Pohl will be succeeded by Helmut Schlesinger, a vice president of the "Buba as the Bundesbank in known in financial markets - who is equally committed to the German tradition of hard money and low inflation. Nonetheless, the Buba may be more circumscribed in the future. The bank will of course remain a major force in policy in united Europe. However, the new guard at the Bundesbank will likely march to a more European tune.

Bankers and money managers represent the creditor class, the central banker's natural constituents. These investors fancy themselves a special breed, ultimate moralists in a world of changing values. Should government debase the currency by printing too much money, they say, we will sell our bonds. That will push interest rates up which, in theory, should discipline the wayward politicians.

According to Hans Tietmeyer, a Buba director, a market economy "necessitates ... a central bank which is largely independent of the government and which is, above all committed to monetary stability.... On principle, the central bank should not be subject to instructions from the government, nor should it be possible to draw on it to finance public budgets. The more independently the central bank can decide on the use of its instruments, the better the results that can be expected."

This paradigm of the central banker as philosopher king, acting in splendid isolation to serve the public interest, has practical limits. Monetary policy has a profound impact on the allocation of resources in a society (not the least between debtors and creditors), and thus is intensely, necessarily political in character.

In real life, central bank independence is a matter of degree. The political process generally determines the broad strategic goals of monetary policy. Some central banks - for instance, the Federal Reserve and the Bundesbank - have tactical freedom to implement these goals. By contrast, others, say the Bank of England or the Bank of France, are subject to explicit government direction.

When finance ministers of the major industrial nations met in Washington last month, most newspeople ridiculed Secretary of the Treasury Nicholas Brady for pressing his colleagues for lower interest rates. That judgment was premature. Monetary policy is relaxing. Italy, France, Spain, England, and Japan either have already responded or will soon do so. While the Germans are not likely to follow suit right away, they now concede they have no case for higher rates.

In theory, central bankers would prefer to keep money tight and drive a final nail in inflation's coffin. Over time, there is no trade-off between inflation and growth. In practice rates are down and money growth is up. For now, these actions are not inflationary. After four years of tight money, the US economy - as just one example - is overdue for a moderate increase in inflation-adjusted money balances.

Nevertheless, the long arm of politics is clearly visible, and with it the implication of possible renewed inflationary pressure. Generals have to fight the wars that politicians make. Central bankers are in the same position as generals. Investors can count on disappointment if they rely on central bankers to maintain stable prices, separate from the national political consensus.