Monetary Policy in America Is a Mess. Things Are Even Worse in Europe

High inflation takes off where political forces are too strong to permit the implementation of harsh remedial measures with respect to taxation and monetary policy such as to prevent an implosion of the national currency. In the contemporary global financial marketplace, there has been fluctuating concern about the US heading toward this point, albeit at a highly uncertain date, as evidenced by waves of attack last spring, summer, and autumn on the US dollar. In reality, though, the long-run inflation threat level is higher in Europe than the US.

Any substantial European remedial action sufficient to arrest in the future a threatened emergence of high consumer price inflation would unleash forces which could potentially sweep away the present status quo of political and economic power. Hence, whatever the immediate cause of the inflation acceleration, we should expect a consensus of policymaking elites—Berlin in full acquiescence—to kick the can down the road.

Currency depreciation is likely to be a crucial part of the dynamic process of high inflation emerging in Europe, as has indeed been the case so often in the laboratory of history. That laboratory lesson indeed applies to the US, and importantly to the origins of the greatest peacetime inflation, which started in the early to mid-1960s.

The story started with the economic miracles in Europe (France, Italy, Germany) and Japan. The Fed, as the monetary hegemon within the Bretton Woods System, should have allowed interest rates to rise sharply as would have occurred under a sound money regime. Instead, the Fed in tune with the aim of the Kennedy administration to repudiate the stop-go policies of the 1950s, steered monetary policy such as to keep interest rates low. As high consumer price inflation emerged from 1965, with a lag behind asset inflation, the Fed did start to let rates rise, even abruptly at times. Sustained bold action, however, would have pushed up dramatically the cost of public sector borrowing, which was then bulging as the Johnson administration waged war in Vietnam and enacted the social programs of the Great Society.

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