The last few months have seen zombie ideas that were safely (or at least mostly) dead rising from the crypt. These actions again proved correct the philosopher George Santayana, who stated, “those who cannot remember the past are condemned to repeat it.”
One such zombie idea has been the influence of the executive branch of government on the central bank. Many countries throughout history have burned themselves with this fire and it seems it is the United States’ turn to take a whirl.
This move is incredibly tempting given the power that monetary policy has: the ability to control the money supply and thus short-run interest rates. Yet this temptation’s siren song has always laid a country’s financial market and economy in ruin for those who succumb to it.
In modern developed countries, there is a strict separation between fiscal policy (the power to raise taxes and spend the corresponding revenues) and monetary policy (the power to control money supply and interest rates).
Congress and the president share fiscal policy while the Federal Reserve executes monetary policy. Each serves a check and balance on the other. The president nominates the Fed’s leadership while the Senate confirms or rejects these nominees, and the Fed is independent to follow the data and markets to set policy.
The combining of fiscal and monetary policy into one person or one branch of government has consistently courted disaster around the world. The most famous example is the aftermath of the Treaty of Versailles in 1919 that ended World War I, when the Allies demanded that the Central Powers pay heavy reparations for the cost of the war.
Since few private investors were willing to purchase treasury bonds to make these payments, the parliaments of Germany, Austria, Poland and Hungary decided to order their central banks to print the money. While nominal interest rates did fall, hyperinflation struck. At its peak in 1923, the German mark was worth about one-115 trillionth of its previous value a decade earlier.
Central banks tried desperate fixes — issuing new currencies and chopping zeros off prices — but nothing worked. Markets require trust and credibility, and both had vanished. What ended what economists call historically the "Four Big Inflations“?
Only when the respective parliaments finally gave central banks independence to say “no” did stability return. From then on, if lawmakers wanted to blow up the deficit, they would need to sell treasury bonds to investors. If investors were unwilling to purchase these assets, then government spending would be forced to a standstill. That independence restored credibility.
This scenario has played out again and again across the globe — from the hundred trillion dollar bill in Zimbabwe to 20,000% inflation in Argentina in the 1990s. Every time lawmakers wanted to bribe the votes of their constituents with huge payments from the treasury and force the central bank to fund it with new money, hyperinflation is the result.
The only solution to avoid this disaster and maintain credibility is to ensure this strict separation. Fed independence is akin to Odysseus binding himself to the mast of his ship to avoid the call of the sirens — however alluring it may have been to relax the bonds separating the hero from the temptation, no good would have come from it.
Inflation is a result of expectations for the future. If firms think their costs will rise tomorrow, then they will begin to increase their prices now. If consumers think dishwasher or car prices will go up, then they will try to move future purchases to the present, pushing demand up, and creating a self-fulfilling prophecy.
If people lose trust that the Federal Reserve is operating independently of political pressure, they will anchor their inflation expectations high, and no bluster or mean tweets will get us out of this cycle.
Institutions are storehouses of trust and credibility. The Federal Reserve is one example of a system that not only runs on legal expectations but also on social trust and social norms. Breaking these unenforceable rules have real world implications and are nearly impossible to rebuild.
During the last presidential election, voters’ main concerns were rising price levels and the affordability crisis. The Fed’s tough medicine to tame inflation is to increase the interest rate, reducing the excess money supply, and suppressing price increases. However, the new administration’s tariff policy and huge deficits from the One Big Beautiful Bill have pushed the inflation monster out of its cage.
Pressuring the Fed through insults, trumped charges and threats of firing to hijack monetary policy will result in higher inflation and crush the shreds of normalcy that voters were starting to sense. Leadership requires policymakers to be honest about costly trade-offs and the long-term consequences.
Let’s not conjure up zombie policies of the past.