German Chancellor Angela Merkel may have sought to score political points by slamming central banks this week, but she also echoed fears over growing public debt and waning bank independence.
Merkel shocked financial markets when she said in Berlin: “We need to get back to an independent central bank policy and a policy of common sense.”
Her rare criticism singled out the US Federal Reserve, as she expressed skepticism over “the extent of the Fed’s powers,” which include the authority to buy US$300 billion in government and private debt.
Merkel’s remarks came days before a rate decision by the European Central Bank (ECB). The ECB, she said, had “bowed to international pressure with its purchase of covered bonds,” a non-conventional measure to boost credit markets.
The comments also preceded a European Parliament poll this weekend and a general election in Germany in September, prompting the Financial Times to call her comments “political point-scoring.”
But the German chancellor’s warning that monetary policy was out of control was welcomed by the Wall Street Journal, which said her “broadside” against the Fed, the Bank of England and the ECB was “timely.”
“Central banks should halt the printing presses before the real damage is done,” the US daily warned.
Merkel and others in Germany feel that pushing up deficits to fight the economic crisis will fuel inflation and sow the seeds of the next crisis.
By buying government debt, some economists say the Fed and Bank of England have surrendered independence that Germans cite as a key factor in a healthy economy.
“There is no real autonomy or independence of the Fed any longer in my view,” UniCredit economist Andreas Rees said. “This is dangerous.”
Meanwhile, “Germans are traumatized by the hyper-inflation in the 1920s,” which helped bring the Nazi party to power, Barclays Capital economist Torsten Polleit said.
“Americans are traumatized by the Great Depression, by deflation,” he said.
Unsurprisingly, Merkel also got the attention of central bank chiefs, with Fed Chairman Ben Bernanke telling a US congressional panel the next day: “I respectfully disagree with her views.”
Bernanke nonetheless warned US lawmakers against failing to rein in a huge budget deficit, saying: “We cannot allow ourselves to be in a position where the debt continues to rise.”
ECB President Jean-Claude Trichet said on Thursday he had spoken with Merkel and was pleased she “was fully backing our independence and appreciated what we were doing.”
Trichet said he and Merkel agreed that governments must be set to reverse the effects of economic stimulus plans quickly once the eurozone’s recession was clearly receding.
“Exit strategies are of the utmost importance,” the ECB chief said.
Financial markets have signaled concern over soaring government debt, as seen in a sharp hike in the yield on US Treasuries and rising momentum of inflation expectations, which nonetheless remain at reasonable levels for now.
“The psychological shift can happen more rapidly” than policymakers expect, Timo Klein at IHS Global Insight Polleit said: “If the program like the one the Fed has announced to keep buying and monetize government debt [continues], the problem will really start to kick in.”
He said that “over the next four to five years, there is just one direction in terms of public debt: It will go up” because “the majority of the public and politicians see government handouts as basically necessary.”
Against such a background, Merkel’s bombshell could benefit the ECB, Klein said.
“In a way, Merkel is actually strengthening the position of the European Central Bank,” he said, by backing those who feel the bank was “coaxed into additional steps by the example of the Fed and the Bank of England and others.”
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