When Wayne D. Angell, who passed for the one of the Fed’s most vigorous inflation fighters, left the Fed in 1994, one of the American newspapers commented on his resignation – Angell leaves, the demon of inflation arrives. However, concerns that inflation would rise were not confirmed. In Poland, it may also be difficult to tell who is a true “hawk” and who is a “dove”.
Senator Robert Dole wrote about Angell that he was an anti-inflation hawk who did everything for the dollar to be as good as gold. He sought to bring both inflation and interest rates to record lows. However, the monetary policy was further tightened and interest rates were raised temporarily to 6%. Average inflation had remained at 2.5% until the end of the decade. Although the Fed’s interest rates sharply declined only in 2001 and remained at a low level of around 1% until 2004, the demon of inflation was not coming.
A dovish policy, hawkish consequences
Today, we know that maintaining prices at low levels for a long time was a mistake, which contributed to inflating the property market bubble. On the other hand, if we deem that keeping inflation low is the central bank’s only duty (the Fed is also required to support growth and employment), the Board of Governors of the Federal Reserve System performed this task well. In the past 20 years, inflation in the United States exceeded 4% only once (4.1% in 2007), five times it was above 3% (1996, 2000, 2004, 2005 and 2011), averaging slightly below 2.5%.
In 2001, the Fed lowered interest rates to stimulate the economy that was undergoing a short recession. In August 2003, the rates were cut to 1% and remained unchanged until June 2004. The real federal funds rate turned negative. In 2003, inflation was below 2%. In the following year, it rose to over 3%, which made the Federal Open Market Committee gradually raise the rates. However, they increased to levels above inflation only in 2005. In his book The Age of Turbulence, Alan Greenspan wrote that the involvement of hundreds of millions of employees in China, India, and Brazil in the process of globalisation resulted in downward pressure on prices throughout the world, which made it possible to keep exceptionally low interest rates without consequences in the form of rising inflation.
Except that a financial crisis developed in the process, of the scale and consequences unprecedented for 80 years. The efforts to mitigate and bring it to a halt induce central banks, and not only the Federal Reserve, to pursue an unconventional policy.
They began as hawks
Greenspan, who took office (appointed by President Reagan) as Chairman of the Board of Directors of the Federal Reserve System in August 1987 was regarded as an anti-inflation hawk. Although President Clinton did not like Greenspan, he reappointed him several times. At a meeting with his closest economic advisers Clinton made an impression of Greenspan intoning: Inflation! Inflation! We are in danger of inflation. Greenspan started his term by ably handling the stock market crash but pursued a very tough monetary policy during his first tenure. The federal funds rate increased to over 7% and in August 1988 – to 8%. Eventually, Greenspan turned out to be a very dovish expert on monetary policy.
Ben Bernanke, who became chairman of the United States Federal Reserve in February 2006, was also regarded as “hawk”. Admittedly, the central bank headed by Bernanke continued interest rate increases, initiated in 2004 towards the end of Greenspan’s term. In July 2006, interest rates were raised to 5.25% and remained at that level until August 2007, when the spectre of the financial crisis was becoming more realistic. At that moment, the anti-inflation hawk turned into a dove. On the eve of the collapse of Lehman Brothers, the federal funds rate stood at around 2%, dropping to nearly zero at the end of 2008, and has remained unchanged for nearly four years.
Bernanke, who considers himself a disciple of monetarist Milton Friedman, is an expert in the economic crisis of the 1930s. He also shares Friedman’s view on the causes of that crisis and responsibility of the Federal Reserve which was incapable of preventing the decline in money supply. In 2002, when he was member of the Fed’s Board of Governors, he said at the ceremony to mark the 90th birthday of the great Noble Prize winner: “Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna (Schwartz – Friedman’s long time collaborator – author’s note). Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
By cutting interest rates practically to zero, Bernanke cited the views of Friedman and Schwartz. However, Schwartz (died at the age of 97 in June 2012) criticised Bernanke, accusing him of “fighting the last war”. By saying so, she meant that he was using tools that would have been adequate in the 1930s but are not the right response to today’s crisis.
The hawk that beat inflation
On the other hand, Paul Volcker, the chairman of the Federal Reserve in 1979-1987 and former adviser to incumbent President Obama, is faithful to his hawkish views. Volcker pursued the most hawkish policy in the history of the Fed. In early 1980s, interest rates were raised to approximately 20% and inflation, which stood at 12.5% in 1980, declined to 3.8% in 1982. Since then, it has only once exceeded 5%, in 1990
In September 2011, Volker wrote in The New York Times: “My point is not that we are on the edge of serious inflation today, which is unlikely if the Fed remains vigilant. Rather, the danger is that if, in desperation, we turn to deliberately seeking inflation to solve real problems — our economic imbalances, sluggish productivity, and excessive leverage — we would soon find that a little inflation doesn’t work. Then the instinct will be to do a little more — a seemingly temporary and «reasonable» 4 percent becomes 5, and then 6 and so on. /…/ At a time when foreign countries own trillions of our dollars, when we are dependent on borrowing still more abroad, and when the whole world counts on the dollar’s maintaining its purchasing power, taking on the risks of deliberately promoting inflation would be simply irresponsible.”
On 30 July 2012, Volcker criticised an unconventional monetary policy, saying that “American policymakers have exhausted fiscal and monetary policy remedies in their bid to cure the US economy’s growth blues. There is no magic bullet in fiscal or monetary policy.”
Volcker is one of the few economists who have remained faithful to his (knowledge- and experience-backed) beliefs and one who has not changed them in the course of the four-year-long financial crisis.
The most dovish of former hawks
Although the crisis has so far only indirectly affected our country, Poland has also seen “hawks” turn into “doves”.
At the beginning of the 2000s, Bogusław Grabowski, member of the first Monetary Policy Council (MPC), was considered a hawk. In 1999-2000, the MPC applied an anti-inflation therapy which led to a fall of inflation to 3.6% at the end of 2001, and to 0.8% a year later. Its side effects were: a strong economic slowdown, a decline in domestic demand in 2002 and a budgetary crisis.
When inflation edged up in September 1999 (from 6.3% to 7.2% y/y), the MPC embarked on a series of interest rate increases. In September 1999, the reference rate rose to 14%, in November – to 16.5%, in February 2000 – to 17.5%, and in August 2000 – to 19%, which had drawn most criticism. Although inflation exceeded 10% y/y from January to September 2000 (except for April) it had started to decline slightly.
Meanwhile, on 30 August, shortly after the MPC had taken the controversial decision, Grabowski said that if inflation did not fall after the supply shocks receded, the MPC would not hesitate to raise the rates again (as cited after Polski IntelliNews). “The MPC is aware that higher rates may result in lower investment and economic growth rates however the monetary policy best contributes to economic growth through long-term monetary stabilisation”, he said.
When the MPC started to cut rates in early 2001, Bogusław Grabowski was a hawk. For example, on 28 March 2001, he was against a 1 percentage point reduction of the rediscount rate and the Lombard rate (with 5 MPC members voting in favour and 5 voting against the reduction; the decision was passed as Leszek Balcerowicz, the NBP President, had a casting vote). In May and June 2001, Grabowski voted against the motion to cut interest rates by 2 p.p.
I am definitely not saying a given opinion was right or was not. I am only stating the fact that Bogusław Grabowski was regarded a hawk during his term in the MPC, although Prof. Marek Dąbrowski was the most hawkish MPC member.
On 16 August 2012, former hawkish MPC member Grabowski turned into a dovish member of the Economic Council at the Chairman of the Council of Ministers.
“The Monetary Policy Council, after it incorrectly raised interest rates in May, should start a cycle of interest rate increases as soon as possible, and cut rates by 75 basis points by year-end”, he said in an interview for the Polish Press Agency. He added that “Lowering interest rates by 25 basis points will mean no lowering at all; it will be just a return to a normal level. It seems to me that this year interest rates should fall to 4%, or they should be cut by 75 basis points. I see no obstacle for the MPC to meet in August and lower the rates (…) I’m shocked by the restrictive monetary policy. I definitely think interest rates didn’t need to be raised in May; this decision now has to be swiftly retracted and a reduction in interest rates should start, given that the monetary policy transmission lags even up to 18 months. In particular, one cannot expect that the exchange rate channel will be used. The response of the exchange rate to risk perception is definitely stronger than to interest rate disparity.”
Again, I am not assessing whether the views of the member of the Economic Council are justified or not. I am only impressed by a U-turn on his views. It is worth noting that the inflation target (2.5% with a fluctuation band of +/–1 p.p.) was last met in November 2010. Inflation has remained above 3% for almost two years now. In July 2012, two core inflation measures decreased, two remained unchanged. The global economic slowdown and its impact on Poland may bring inflation down (as recession brought inflation down in 2002) but for the time being it is higher, by 1 percentage point, than the inflation target including the fluctuation band.
Dovish and hawkish accounting
The member of the Economic Council has also totally changed his hawkish views on the NBP accounting. When in 2003 the then Minister of Finance Grzegorz Kołodko wanted to make use of the revaluation reserve, the then MPC member Grabowski strongly protested against the move. “Viewed from a macroeconomic angle, there is no justified reason for using this virtual money shown on the NBP’s balance sheet”, he said in an interview for Gazeta Wyborcza (24 March 2003). He also suggested there was a need to revise the central bank’s accounting rules in a way enabling it to retain all profits instead of transferring them to the State budget.
However, when in early 2010 a conflict arouse between the NBP Management Board and some MPC members on the portion of the Bank’s profit to be contributed to the State budget, the former hawk turned out to be a dove again.
“Profit is not a matter of negotiation. It is a detailed calculation performed by accountants who have to act in accordance with the rules (…) It is the Council that has the right to decide and has the sole casting vote in this matter”, he said in an interview for Radio PIN in April 2010.
Radio PIN: “In that case, who is questioning legal reality – the Management Board or the Council?”
Grabowski: The Management Board, of course. There’s no doubt about it. (…) The Act on the National Bank of Poland is very simple, explicit and indisputable in this respect.”
In 2003, the member of the PM’s Economic Council found it “simple, explicit and indisputable” that the revaluation reserve should be calculated in the most conservative way and the NBP should retain its profit rather than contribute it to the budget. In 2010, opposite views became “simple, explicit and indisputable”.
Yet, the matter was not that simple for a considerable number of specialists. Let me remind you that in 2010, the majority of MPC members defended the “government” method of calculating the NBP profit as the NBP Management Board and three MPC members appointed by President Lech Kaczyński were against it. In 2010, an MPC member Andrzej Bratkowski, who in 2003 in the capacity of Deputy President of the NBP defended in the Sejm the independence of the Bank from politicians, threatened to resign from the Council, if the… government agreed to a smaller contribution from the NBP. Nowadays, the former hawk is one of the most dovish MPC members. In July 2012, he was the only MPC to vote in favour of cutting interest rates by 50 basis points.
Hawks are still alive
Doves happen to turn into haws, although less frequently. For example, Zyta Gilowska had a dovish approach to interest rates when she was Deputy Prime Minister and Minister of Finance. “I see no need to raise interest rates”, she told Polskie Radio in a March 2007 interview. She said that the Polish economy was not overheated and there was no risk of inflation growth. Meanwhile, the overheating of the economy was visible to the naked eye. Although in March 2007 inflation amounted to a mere 1.1%, in October it jumped to 3% and in November to 3.7%, exceeding the inflation target including the fluctuation band. As member of the MPC, Zyta Gilowska is a hawk. She voted in favour of interest rates increases and against interest rate reductions almost every time.
Prof. Dariusz Filar, the MPC member in 2004-2010, stands out against hawks turning into doves or vice versa, and his approach was exceptionally consistent. He was regarded as a hawk in the Council. In early 2006, he voted (contrary to the majority) against interest rate reductions, and from October 2006 he was part of the minority who voted in favour of initiating interest rate increases during successive MPC meetings.
Commenting on the current controversies over the level of interest rates, Professor Filar said: “The MPC should stabilise interest rates over the coming 2-3 quarters. It would be appropriate to maintain the existing level of monetary policy restrictiveness and nominal interest rates should be stabilised over the coming 2-3 quarters. Core inflation at 1.0-1.1% would help to meet the inflation target expressed as CPI at 2.5%.”
By Witold Gadomski