Inflation and diplomacy - Axel Weber edition

Axel Weber, the current President of the Bundesbank, is resigning in May of this year. He also won't seek office as head of the ECB. There is a good deal of gloating in the press about him going. A well-known inflation 'hawk' and an opponent of the ECB's bond-buying extravaganza to keep Greece & Co. afloat, he is widely considered not diplomatic enough for leading the ECB. For example, his open dissent about the bond purchases last year is seen as an unacceptable lack of esprit de corps.

To be honest, the whole logic of this line of reasoning is passing me by. Central bankers are not diplomats. At some point, Western countries decided that independent, technocratic institutions are better at making monetary policy than politicians. The Fed under Volcker, and the Bundesbank under Hans-Otto Pöhl, are excellent examples of how to do this right. Was there anything diplomatic about raising interest rates in the middle of a recession, as both of them did in the early 1980s? For sure not. They courted controversy, told smooth-talking politicians begging for some easy money to take a hike, and helped to bring inflation (and inflationary expectations) under control. In the long-run, there is no tradeoff between inflation and unemployment; only dead inflation is good inflation.

When the ECB was set up, it was meant to inherit the inflation-fighting prowess of the Bundesbank. One shouldn't exaggerate the implications of a single personnel decision, but I see a broader pattern that is turning the ECB into more of a mixture between the Bundesbank of old and, say, the bad old Bank of Italy or Banco de Espana, which presided over double-digit inflation for decades. Where Pöhl and friends would hike interest rates overnight by a few hundred basis points, with no warning, cold-turkey style (even the early Greenspan pulled one of these off), the new regime hopes to guide expectations through the most esoteric of shifts in bureaucratese, thinking that if they say "strong vigilance" against inflation instead of "vigilance", bond markets and the economy at large will get it. Interest rates? Almost never shall they be touched, and if so, by 25 basis points every 6 months, maybe.

So far, the inheritance of strong inflation-fighting credentials from the past, plus a benign macro environment, have ensured that this sort of magic worked surprisingly well. But at some point, I fear that stronger medicine will be needed - someone, at some point, will have to do the ugly thing of raising interest rates, big-time, perhaps even if growth is not looking pretty, because inflation is too high. Who are you going to call? Suave, smiling diplomats, who got their jobs by being nice to their home country politicians, or by working for Goldman Sachs? Or blunt, robust characters with solid academic qualifications, like Axel Weber? For my money, the fact that he was a bit rough around the edges, said what he thought, didn't take his views from the editorial pages of the FT, and wasn't afraid to p*** off some politicos, was the strongest set of recommendations anyone could have for the top job. Shame that it's not the kind of person who will lead the ECB.

Inflation watch...

Who issues currency? Well, of course, governments and central banks do. But if you think about it, up to a point, airlines do, too. The miles you accumulate, what are they worth? You can redeem them for a plethora of goods, from flights and upgrades to hotel stays and donations to charity. You can even pay your (flight) taxes with them. Given that more and more economists are starting to think that perhaps, with inflation above the ECB target, we should worry about price pressure, it is interesting to see that Lufthansa has just (effective January 2011) decided to devalue its own currency. While some award requirements stay the same, others are going up by a whopping 17%. I am sure they will say that they haven't adjusted them for years. Well, since the price of their flights changes in terms of "real" money, it is not clear to me that this is much of an argument -- the value of the miles fluctuates with the value of the normal tickets, so there is no reason why they should change at all.

So here is your lesson - miles are really just like fiat money. If Lufthansa (or any other airline) decides that tomorrow, your miles are worth 90% less, there is nothing you can do about it. And if you look at the charts in Reinhart and Rogoff's book on average inflation since 1500, you see very clearly that the overall pace of inflation has accelerated hugely since the introduction of pure fiat money in the 1970s... So if miles are a bit like fiat money, what is the limit of the analogy? Getting and spending are oddly tied up with airmiles, in a way that is not the case with normal money. The only way you can accumulate enough miles for a nice award is to fly so much that you don't want to see another plane for a very long time [yes, I just came back from the Boston area, where, inter alia, I gave a couple of talks about the M.Sc. programs at Barcelona GSE /UPF].