‘Normalisation’ of Monetary Policy: The Candour Behind the Curtain – Part One


In previous articles and economic updates I have written about how central banks are in the process of ‘normalising‘ monetary policy and have been using fundamental data such as the stock market, inflation, job creation, oil prices and GDP to assist in justifying their actions and future intentions.

The Federal Reserve were the first major central bank to begin a sustained course of interest rate hikes as part of their programme of policy ‘normalisation‘. In the eight years of Barack Obama’s presidency, the Fed raised rates just one time in December 2015. The next rise would come in December 2016, in the period between Donald Trump’s election victory and his subsequent inauguration. Since then, the Fed have raised rates a further two times in 2017 and are now preparing to start reducing the size of their $4.5 trillion balance sheet.

However, the Fed’s original cover of fundamental data being a prime motivation for ‘normalising‘ policy has been running contradictory to the rate of inflation in the U.S. The last rate hike in June came in the midst of falling inflation, which the fed were quick to proclaim as ‘transitory‘. From their own communications, they expect inflation to pick up throughout the autumn and winter months. But this does not change the fact that the Fed have shown themselves quite willing to increase rates as economic data stagnates or declines. A critical fact to consider at this point is that U.S. consumer debt now stands at a record $12.6 trillion, at a time when the cost of servicing debt becomes more expensive as rates rise.

Other central banks, such as the Bank of England (BOE) and the European Central Bank (ECB), have gradually been adopting a more ‘hawkish‘ stance on monetary policy. Whilst they have yet to either raise rates or begin selling off assets, the language emanating from these institutions correlates with the change in tone from the Bank for International Settlements (BIS) – otherwise known as the ‘central bank for central banks.’

I have argued for many months how the ‘normalisation of monetary policy‘ narrative is a centralised directive, and that central banks are the vehicle for carrying out such measures. The Federal Reserve publicly began the process, and as they continue their programme of ‘normalisation‘ fellow central banks are slowly preparing their own tightening of policy.

A name often mentioned throughout my economic updates is Jens Weidmann, who is Chairman of the German Bundesbank and Chairman of the Board at the Bank for International Settlements. As far back as 2014, Weidmann was openly criticising the ECB’s stimulus measures. Three years later, Weidmann continues to play the policy ‘hawk‘, evidence for which can be found in the various speeches he delivers to venues around Europe. The BIS’s website archives every major speech from central bankers, but given the prominent role which Weidmann enjoys both in Germany and on the board at the BIS, his voice is one that should be attracting far more attention than it currently does.

Having compiled and studied Weidmann’s perspective on ‘normalising monetary policy‘ over the past year, let’s now examine the term (from a European perspective) and look beyond the emotional rhetoric of economic channels in both the mainstream and alternative media.


Weidmann has long since stated that the ultimate objective of a central bank is price stability. According to the ECB, this means to ‘maintain inflation rates below, but close to, 2% over the medium term‘. The Federal Reserve’s definition is borderline the same. How to achieve such stability, though, is a topic which Weidmann often returns to and where he is at his most candid.

The basis of the 1992 Maastricht Treaty agreement is a good place to begin. The purpose for the treaty as Weidmann sees it was for the creation of a single currency in Europe, but to allow member states to continue to define their own economic and fiscal policy independently. As a result, the direct financing of government debt by central banks in Europe is banned.

The treaty was a step towards further integration of EU states. To evolve towards deeper political integration e.g. a political union, Weidmann presents two possibilities:

  • The first is that member states hand over decision making powers to a fiscal council, in turn ceding sovereignty. Responsibility for fiscal surveillance of nations would be assigned to an independent authority, and countries would have to adhere to binding fiscal rules.
  • The second is that each country’s government bares personal responsibility for the consequences of their decisions – an eventuality which is known as the ‘no bail out clause‘.

The first option is outright centralisation of economic power, whilst the second is on the surface the decentralising of power.

According to Weidmann, the no bail out clause can only function ‘if it is possible, in extreme cases, to restructure sovereign debt without jeopardising the stability of the financial system.’

The reason that he touts such possibilities stems from the ‘ultra accommodative monetary policy‘ of the European Central Bank, measures which have ‘blurred the boundary between monetary and fiscal policy.’ By Weidmann own’s reckoning, central banks have become the ‘largest creditors of its member states.’ The longer the process of ‘ultra loose monetary policy‘ continues, the more its ‘positive effects will diminish and undesired side effects will become more visible.’ What Weidmann is predominately talking about is the danger of rising inflation on price stability in the midst of the ECB continuing with their accommodative monetary measures.

Of real importance here is when Weidmann states that monetary policy has subsidized ‘unsound fiscal policy through low interest rates‘. The era of low rates over the past nine years is something which governments have failed to take advantage of to ‘consolidate budgets more quickly.’ Instead, government spending has risen, which in turn means interest payments on government debt has also increased. Given the environment of low rates, however, the narrative goes that governments have not been incentivised to pay down their debts.

For Weidmann, higher levels of debt have become more sustainable because of low interest rates. Savings from 0% interest have not been put towards reducing national debt, but have instead been spent. In short, low interest rates have meant the acquisition of more debt. Low rates have therefore created an ‘illusion of sustainability‘, with the debt burden of nations seen as being lighter than it would be under ‘normalised‘ interest rates. In Weidmann’s own words:

Governments have to be aware that debt will be much more difficult to service once interest rates rise. That is another reason why fiscal consolidation is important.

This is exactly the situation which the United States now faces and one which the UK and EU nations are likely to soon experience.

Accompanying increased debt levels is the tepid levels of growth in the global economy. Recent GDP numbers in the U.S., UK and the EU have been marginally positive but do not meet the requirement of long term sustainable growth. For nations to prosper, Weidmann thinks it is the politicians who hold the power, which is why he supports calls for structural reform on competition and innovation to make it easier for new firms to enter the market place. Skills and Education are cited as the two main arms where government investment is required.

This brings us back to the centralisation vs decentralisation of power. For Weidmann, a decentralised structure means that policymakers who make decisions cannot expect other nations to ‘step into the breach if they come unstuck.’ Sound public finances therefore have to be the responsibility of national governments. The motif of ‘central banks are not the only game in town‘, a term which IMF head Christine Lagarde is fond of using, applies in this scenario.

Ultimately, the centralisation of power is a common theme which runs throughout the EU project. Helmut Kohl, who died in June 2017 and was both leading architect of the Maastricht Treaty and Chancellor of Germany from 1982 to 1998, is credited by Weidmann as saying:

It cannot be said often enough: political union is the indispensable counterpart of economic and monetary union.

Weidmann expanded on this in one of his speeches by presenting two contrasting theories for achieving the goal of a political union. The first is what’s known as ‘The Coronation Theory‘ – this is where a monetary union stands at the end of the European integration process. If economies had failed to integrate sufficiently, a single monetary policy would prove impractical for the union as a whole and would leave it prone to crisis.

The second theory is ‘The Locomotive Theory‘, which runs in contrast to ‘The Coronation Theory’. It is when ‘the integration of one sub sector will necessitate the integration of other areas‘. As Weidmann put it, the theory uses ‘crisis as an opportunity‘:

Crisis, first and foremost, opens up the possibility of implementing those steps of integration that have not yet been taken.

Whilst discussing this theory, Weidmann used examples such as the Brexit vote in the UK to state that:

Even now there is no lack of proposals that the appropriate response ‒ not only to the Brexit vote but also the euro-area financial and sovereign crisis ‒ should be even more integration.

The two leading geopolitical triggers in the world today revolve around the Presidency of Donald Trump and the UK leaving the European Union, events which based on the evidence I believe are working in parallel with the ‘normalisation‘ of monetary policy programme emanating from central banks. Over time, the gradual removal of stimulus measures coupled with rising interest rates will put an intolerable strain on government and public debt levels. Which is why institutions like The Bank for International Settlements are utilising geopolitical instability to advance their ‘normalisation’ agenda. As a result, culpability for an economic downturn is likely to be held up as a consequence of events stemming from Trump and Brexit. The actions of central banks become secondary at exactly the time when they should be most prominent in people’s minds.

***

In part two we will look further into Jens Weidmann’s perspective on monetary policy and how it correlates with the global objective to fully centralise economic power.

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