Monetary Policy Expert David Marsh

"We Are Witnessing the End of Independent Central Banks"

Former investment banker David Marsh is critical of the European Central Bank and the U.S. Federal Reserve for having transformed themselves into political instruments. Inflation, he says, isn't dead - and it will come back.

Interview Conducted by Tim Bartz

DER SPIEGEL: Mr. Marsh, the U.S. Federal Reserve (Fed) has just bid farewell to its inflation target and is now tolerating inflation rates above 2 percent. The European Central Bank (ECB) could soon follow suit. Will inflation soon be making a comeback?

Marsh: I wouldn't be so defeatist, but it is clear that a new era is dawning. The Fed is further constraining the ECB’s freedom of maneuver.


Marsh: The Fed has always been careful to keep inflation and unemployment under control with its monetary policy. That is now over. Because of the pandemic, unemployment has risen sharply, and at the same time, inflation has been very low for 10 years. There are reasons for this, but they have nothing to do with the central banks.

DER SPIEGEL: What are the reasons?

Marsh: People are getting older and saving more. Digitalization is covering companies' capital requirements. Globalization has brought millions of new people into the labor market, which has driven down wages. All of this has put the brakes on inflation. From now on, fighting inflation is no longer the Fed's most important goal. And we also have very low inflation rates in Europe.

DER SPIEGEL: If inflation is no longer a problem, why is the Fed's decision to tolerate higher consumer prices such a big deal?

Marsh: Because inflation is not dead, but can once again become a real danger given the debt-financed government spending deployed in the fight against the pandemic. The central banks should be ready to fight rising inflation rates. But they are abandoning the fight.

DER SPIEGEL: How much inflation are we actually talking about? There are some believe the global economy is heading back to the hyperinflation of the 1920s.

Marsh: I think that's completely exaggerated. If industry recovers from the corona shock, prices could rise by well over 2 percent. That would be just fine for politicians, because if prices rise, the nominal gross domestic product also grows. And as long as that increases faster than debt, the sovereign debt level will melt away essentially automatically.

DER SPIEGEL: What would be great for finance ministers …

Marsh: ... but would be accompanied by social injustice. Those who own their own homes or stock portfolios are happy because both become worth more with inflation. But those who have hardly any assets and live in rented accommodation feel rising prices much more directly. The gap grows bigger, which in turn helps the populists. We see this happening already.

DER SPIEGEL: Critics say that the basket of goods and services used by the ECB to measure the inflation rate, which in turn is used as the basis of its monetary policy, is calculated incorrectly. Do you agree with that criticism?

Marsh: I think so, yes. The real inflation is higher. As I said: Real estate prices, including rents, are decisive for the cost of living and the shopping basket does not reflect that. But that is not the real problem.


Marsh: The politicization of the central banks. The new Fed strategy is the strongest sign that the central banks are taking on more and more tasks for which politicians are responsible, such as fighting unemployment. The ECB, which intends to present its new strategy in 2021, will follow in the Fed's footsteps. We are witnessing the end of independent central banks - which was partly a myth anyway.

DER SPIEGEL: They were never completely independent …

Marsh: Ever since the Fed announcement, this myth has been shattered. The central banks are more politicized than they have been for decades. In Japan, this has been the case for a long time. In Europe, French President Emmanuel Macron set an example in this respect by cleverly taking Chancellor Angela Merkel by surprise and making Christine Lagarde president of the ECB.

DER SPIEGEL: So we have a situation in which inflation is higher than the official figure, which central banks tolerate – first tacitly, but now officially. And that is done as a way to support nation states? The accusation of central banks providing state financing is one of the harshest that can be made.

Marsh: It is more complex than that. In general, it is quite right that central banks support goals set by politics. But they must not lose the ability to do the opposite when necessary, for example when inflation rises. Central banks must not allow governments to use inflation as a weapon against debt.

DER SPIEGEL: Did Fed Chairman Jerome Powell cave in to Donald Trump? The president had been tweeting for quite some time that the Fed should ease the reins to allow more growth.

Marsh: On the one hand, Powell has adjusted strategy to reality. At the same time, the colossal public pressure that Trump has been exerting has had an effect. When Trump summoned him to the White House at the beginning of 2019, Powell should have said: "Get my secretary to give you an appointment, but not for six months." Of course, he didn't do that.

DER SPIEGEL: Monetary policy is never static, like politics in general. Powell's successor can change the strategy again if inflation rises too much.

Marsh: And he will. And that will be easier for the US Federal Reserve than for the ECB - a huge problem.


Marsh: Because eurozone member states are growing at radically different speeds. Germany could tolerate inflation rates of 3 to 4 percent, if only to reduce its export surplus. But that would be practically be the death knell for Italian competitiveness. The eurozone does not have a finance minister or an economics minister because there is no political union. This is the birth defect of monetary union.

"In terms of political cohesion in the eurozone, the ECB must take into account the wishes of countries like Germany."

DER SPIEGEL: ECB President Lagarde is urging eurozone member states to spend more money because the ECB is not omnipotent. Was that overdue?

Marsh: Yes, the monetary policy of the ECB was too lax for a long time, the fiscal policy of eurozone member states, especially Germany's, too strict. Fortunately, this has changed owing to the corona shock. The European Union’s recovery fund goes in the right direction. It's just as well that we British, the eternal nay-sayers, have departed. We would probably have prevented the fund from being established.

DER SPIEGEL: Is it not dangerous for governments to fund their aid programs with money generated by bonds the ECB buys on the market?

Marsh: It is. Germany is very sensitive to this type of public financing. This endangers the cohesion of the eurozone.

DER SPIEGEL: What should the ECB do?

Marsh: Announce in a sensitive yet decisive way that it will stop buying government bonds from mid-2021 if the economy has significantly recovered by then and if there is no further wave of infection. It urgently needs to signal that it is considering monetary policy normalization. Then, it can also be more flexible with regard to the inflation target. It must not give finance ministers the impression that it is always there for them. It was right for Lagarde to go all out in the pandemic. But in terms of political cohesion in the eurozone, the ECB must take into account the wishes of countries like Germany.

DER SPIEGEL: If the ECB stops buying sovereign bonds, two things will happen: Bond prices will fall, and interest rates will rise. It would be much more expensive for highly indebted countries like Italy, France and Spain to incur new debt. The alternative would be drastic austerity programs. That is something Macron will have to prevent if he wants to be re-elected in the next presidential elections in 2022.

Marsh: Despite difficulties from the Fed’s decision, the ECB must implement its own strategy, with subtlety and understanding. Otherwise it runs the risk of being made the scapegoat for everything that goes wrong.

DER SPIEGEL: Isn't it already too late?

Marsh: Not yet. That would only be the case if it buys government bonds directly from governments, or if the majority of central bank heads were ex-finance ministers like Lagarde. That is why it is so important to see who will succeed Yves Mersch of Luxembourg in the six-member ECB Executive Board at the end of 2020. If it were a politician, that would cross a red line.

DER SPIEGEL: Do you think that the ECB will be an issue in the 2021 election campaign in Germany, for example with regard to low interest rates and the German obsession with savings?

Marsh: I don't think so. Social cohesion in Germany is not working as well as it used to, because of the gap between the well-off and the less well-off. But compared to many other countries, the Germans are doing just fine. The outcry in Germany against the ECB’s bond purchases has been limited.

DER SPIEGEL: Will the eurozone survive?

Marsh: The error of not establishing a political union must be corrected. There are only two ways to get out of this impasse: Either the monetary union shrinks. Or it changes into a transfer union, for which the Germans in particular have to pay - with the danger of overreaching themselves. One of these two extreme options will prevail, probably the transfer union. Simply muddling through no longer works.

DER SPIEGEL: The Germans benefit most from the eurozone as an export market. Why should they overreach themselves?

Marsh: If it were so clear that the net effect is positive, then everything would be fine. But as so often, it depends more on perception than on reality. The next chancellor will have to take responsibility for this. It would need a chancellor with outstanding communication skills who can convey the benefits of the eurozone to the populace. Ever since Helmut Schmidt, Germany has not had such a politician. What is needed is a German Macron, but no matter how far and wide I look, I don’t see one coming.

David Marsh, 68, is a wanderer between the worlds. In the 1980s and '90s he worked as a journalist for the Financial Times, before then switching to investment banking and became a consultant. Marsh is British, yet he is also a profound expert on Germany and is the author of the standard work "The Bundesbank: The Bank that Rules Europe." He is also a recipient of the German Order of Merit. Today, as head of the Official Monetary and Financial Institutions Forum, the think tank he founded, he focuses on his favorite topics: Economic policy and central banks. The latter, he believes, are degenerating into appendages of governments because they are increasingly engaged in state financing.

The exception

Why is Wall Street expanding in China?

It may be a step on the way to China becoming a financial superpower

n the tech industry the rupture between China and America continues to grow. Will Uncle Sam force a sale of TikTok, a Chinese-run app popular in the West ? Can Huawei survive the embargo? Is Apple shifting its supply chains from China? Yet in one part of the global economy the pattern is of superpower engagement, not estrangement: high finance. BlackRock, a giant asset manager, has got the nod to set up a Chinese fund business.

Vanguard, a rival, is shifting its Asian headquarters to Shanghai. JPMorgan Chase may spend $1bn to buy control of its Chinese money-management venture. Foreign fund managers bought nearly $200bn of mainland Chinese shares and bonds in the past year.

Far from short-term greed, Wall Street’s taste for China reflects a long-term bet that finance’s centre of gravity will shift east. And unlike in tech, both sides think they can capture the benefits of interaction without taking too much risk.

Western, and in particular American, capital markets still reign supreme on most measures. Derivatives are often traded in Chicago; currencies in London. American firms dominate the league tables in asset management and investment banking. The White House has sought to weaponise America’s pre-eminence, by pushing Chinese firms to delist their shares from New York, for example.

But if anything the trade war has shown the growing muscle of China in finance. A big wave of ipos is taking place in Hong Kong, often done by firms keen for an alternative to New York.

China’s prowess in fintech will soon be centre-stage with the listing of Ant Group, which may be the world’s largest ipo ever. And then there is the surprising rush of Wall Street firms and other foreign investors into mainland China.

They have been knocking on the door for 30 years with little success. Now they are betting that China is serious about welcoming foreign finance. With its current-account surplus set to fall over time, or even fall into deficit, it needs to attract more foreign capital. The terms of access have improved.

China is at last allowing Western firms to take control of their mainland operations and has made it easier for fund managers to buy and sell mainland securities. The potential prize is vast: a new source of fees for Wall Street banks, and for fund managers a huge universe of potential customers and companies to invest in.

There are risks. China could bend the rules to protect local banks and brokers. Corruption is a hazard: in 2016 JPMorgan Chase was fined by American regulators for giving jobs to well-connected Chinese “princelings”.

Worries over human-rights abuses may intensify. And navigating America’s sanctions regime will be tricky—global banks active in Hong Kong, such as hsbc, are already under pressure to cut off some Chinese officials there.

Yet American financial firms’ exposure to China is low enough that they have little to lose. The tech industry is dangerously dependent on China: Apple assembles many of its devices there.

By contrast, the top five Wall Street banks have only 1.6% of their assets exposed to China and Hong Kong.

China’s ability to attract Wall Street firms during a bitter trade war shows the clout its capital markets have. But to become a financial superpower it would need to create its own global finance and payments infrastructure and make the yuan more freely convertible. The leading Chinese firms have a tiny presence abroad (just 5% of revenues for Ant) and most of China’s trade is invoiced in dollars, making it vulnerable to American sanctions.

Building an alternative to America’s global monetary network is a huge task that will take years and require China’s control-obsessed officials to loosen their grip further. Still, the trade war has given China a big incentive to take the next step.

What could go wrong?

America’s ugly election

A disputed result in November could be dangerous

Labor day marks the beginning of the home straight in a presidential election. This one threatens to be ugly. The president’s supporters are clashing with Black Lives Matter protesters in Portland, Oregon. Donald Trump flew to Kenosha, Wisconsin, for a photo-op in front of burned-out buildings, a week after police shot and paralysed an unarmed African-American man and one of the president’s supporters shot and killed two demonstrators, possibly in self-defence.

Having adopted a strategy built around profiting from fears about unrest, the president has an interest in stoking it. Many Americans worry that November could herald not a smooth exercise of democracy but violent discord and a constitutional crisis.

Is this all hyperbole? America has had violent, contested elections in the past. In 1968 one of the candidates, Bobby Kennedy, was assassinated. In 1912 Teddy Roosevelt was shot in the chest while making a speech in Wisconsin. (He finished the speech before heading to hospital, and survived.)

Historians are still arguing about who really won the election of 1876. Yet the country has always managed to gain the consent of the losers in its presidential elections—even in the midst of the civil war. That long unbroken streak suggests that doomsayers need to keep things in proportion. However, there is a real risk that things could go wrong in November.

To ensure the peaceful handover of power, democracies need the losing candidates and most of their followers to admit defeat. A clear result on polling day helps a lot: the losers may hate it, but they accept it and start preparing for the next election.

When the result is unclear, a backup system is needed. Contested election results are rare in mature Western democracies, but they happen. In 2006 Silvio Berlusconi narrowly lost an election in Italy and claimed, without evidence, that there had been widespread fraud.

The country’s Supreme Court ruled in favour of his opponent, and Mr Berlusconi grudgingly surrendered. In 2000 America’s presidential election was settled in the Supreme Court after contested recounts in Florida. In both cases, decrees from judges were just about enough to end the squabbling and let the country move on.

In the case of a landslide win for Mr Trump or Joe Biden, about half of America will be miserable. Many Democrats view Mr Trump as a threat to democracy itself. If he wins again millions of them will be distraught. Among Republicans, by contrast, Mr Trump still enjoys an 87% approval rating. If he loses, many will grouse that the other side cheated.

But that need not stop a smooth transfer of power if the margin of victory is big enough. If Mr Trump were to lose by eight points, as polls currently suggest he will, there will be no way to challenge the result plausibly—though he may try anyway, possibly fomenting further unrest.

If the election is much closer, things could get even uglier. America is unusual in the degree of power it gives to Republican and Democratic partisans to administer elections. Decisions over who is removed from lists of eligible voters when they are updated, the design of ballot papers, where polling stations are situated, whether early voting is allowed and how many people have to witness a postal vote—things which in other mature democracies are in the hands of non-partisan commissions—are all taken by people with a d or an r by their name.

If the election is close then all this will be litigated over, and ultimately end up in courts presided over by judges who have also been appointed by Republican or Democratic governors and presidents.

As if that were not worrying enough, covid-19 could add to the legal slugfest. Already more than 200 covid-related lawsuits have been filed by the campaigns (see Briefing). The evidence from party primaries suggests that though some states, such as Wisconsin, conducted a relatively orderly election despite the virus, others did not.

Postal ballots were still being counted weeks after election day in New York’s primary. In November some swing states, including Michigan, will experiment with widespread voting by mail for the first time.

If the election is close and there are delays in counting ballots on election night, it could well appear that Mr Trump is winning in some key states. He might then claim victory before the results were in, as he did in Florida’s 2018 mid-terms.

As more postal votes are counted, the result could then shift in Mr Biden’s favour. America would have two candidates claiming victory. Electoral cases in multiple states might have to be heard in the courts. Protests would surely erupt, some of them armed.

The president might call out the national guard, as he threatened to do this summer, or send federal agents into Democratic cities to police restive crowds, as happened in Portland. At this distance, it is easy to forget quite how wrenching a disputed presidential election was in 2000.

And that dispute took place at a time of maximum American self-confidence, before 9/11, before the rise of China, before elections were fought on social media, and when the choice was between two men who would be considered moderate centrists by current standards.

Now imagine something like the Florida recount taking place in several states, after an epidemic has killed 200,000 Americans, and at a moment when the incumbent is viewed as both illegitimate and odious by a very large number of voters, while on the other side millions are convinced, regardless of the evidence, that their man would have won clearly but for widespread electoral fraud.

Were Mr Trump to lose the popular vote but win in the electoral college, as happened in 2016, then almost 40% of Democrats say that the election ought to be re-run. It should not. Were he to lose the presidency, then almost 30% of Republicans think that it would be appropriate for Mr Trump to refuse to leave office if there were claims of widespread illegal voting—claims he has already made in relation to postal voting. It would not.

There is so much riding on this election—for America and for the rest of the world—that state officials must do everything they can to make sure it goes as smoothly as possible, remembering that they owe loyalty to the constitution, not their party.

Even a landslide election win will be fraught. In the event of a narrow one, America might not be able to generate losers’ consent. And without that, democracies are in big trouble.

ECB must follow the Fed’s embrace of a second mandate

It is wrong to think central banks must stick to monetary concerns and avoid economic policy

Martin Sandbu

US Federal Reserve chair Jay Powell. The Fed will no longer worry about ‘deviations’ from full employment, only ‘shortfalls’ © AFP/Getty Images

One word can move a mountain. Last week US Federal Reserve chair Jay Powell announced that the Fed’s updated policy strategy will no longer worry about “deviations” but only “shortfalls” from full employment so long as inflationary pressures are absent.

In other words, it will not tighten monetary policy to prevent “overheating” just because more Americans get jobs than economists thought was possible.

This is excellent news, and a great credit to Mr Powell and his colleagues. They have listened with empathy to those on the margins of the labour market, who are the last to benefit from economic expansions and the first to suffer from slowdowns. They have believed their eyes more than models predicting tight labour markets must push inflation up. In practical terms, it signals a big dovish shift by the Fed. American workers and investors all have reason to thank Mr Powell.

But let us temper the acclaim: the Fed is merely catching up with its own legal duties. The Federal Reserve Act mandates the US central bank “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates”. The instructions never called for preventing employment from going too high (or unemployment too low) in its own right. Yet that is how the Fed, with the approval of most economists, behaved for too long, reining in recoveries long before any inflation was ignited.

Europeans should pay close attention. For the European Central Bank has also treated its own legal mandate far too narrowly. There is a widespread misperception that the ECB is treaty-bound to the single duty of ensuring price stability. The central bank shares the blame for allowing this error to proliferate, sometimes seeming to believe it itself.

In fact, EU treaties mandate not one but two objectives for the ECB. The first is price stability. But beyond this, the ECB has a legal obligation to “support the [EU’s] general economic policies” and contribute to the objectives “laid down in Article 3 of the Treaty on European Union”. Article 3 calls for full employment, improvements to “the quality of the environment”, economic and social cohesion and social justice and protection, among other goals.

True, price stability is the primary mandate. But the popular idea that the ECB is charged with monetary policy only and must stay away from economic policy has no foundation in the treaties. On the contrary, the ECB is obliged to promote specific policies, namely those of the EU as a whole, so long as that does not conflict with its pursuit of price stability. This neglected fact has a number of far-reaching implications.

One is that when the German Constitutional Court ruled against the ECB’s bond-buying programme in May, it got things exactly wrong. While the judges argued the ECB must consider the economic policy consequences of its monetary decisions, they posited their own such policy priorities, largely reflecting the interest of savers, and ignored the very different economic policy goals explicit in the treaties.

Another is that the ECB is not only allowed to incorporate climate change considerations into its monetary policy framework, as its president Christine Lagarde clearly favours, but it is legally required to do so. After all, the environment is a treaty objective, and the European Green Deal is a flagship economic policy of the EU.

A third is that the ECB erred badly a decade ago in its participation in the “troika” of creditors in the fiscal rescue programmes for countries hit by the eurozone sovereign debt crisis. On many occasions the central bank pushed for fiscal and structural policy changes that ostensibly favoured debt sustainability (in fact they were often counterproductive) over such treaty-mandated goals as social protection, cohesion and full employment.

But most importantly, taking its full legal obligation seriously means the same for the ECB as for the Fed. While the ECB must strictly prioritise inflation, unlike its American counterpart’s more balanced dual mandate, it has no more right than the Fed does to rein in “excessive” growth if inflation remains under control. And yet the ECB’s own explanation of its second mandate still says it should avoid fluctuations — not just shortfalls — in output and employment.

In practice, the ECB has been taking much better care of its employment mandate in recent years. Some of its policymakers are becoming more outspoken about its legal obligations beyond inflation. But old ideas die hard. The ECB would do well to follow the Fed’s lead, even if it comes down to a single Word.