Last week, Trump criticized the Federal Reserve for raising interest rates, claiming that he doesn’t like “all of this work that we’re putting into the economy and then I see rates going up”. Likewise, the newly emboldened Turkish President Erdogan has increased his grip on Turkey’s Central Bank (whose actions made the Lira plummet this week), as he holds the unorthodox view – to say the least – that lower interest rates will solve Turkey’s inflation problem. And Italy’s new “government of change” is poised for going on a huge spending spree, dramatically increasing Italy’s budget deficit and adding to its already huge government debt of 132% of GDP, thus further violating the agreements of the Eurozone’s Stability and Growth Pact.
What does this mean?
These actions all fit the paradigm of “economic populism”, which stresses growth and income redistribution while deemphasizing the risks of deficit finance, inflation, and other external constraints (e.g. market reactions to these policies). A paradigmatic case was when Latin American populists in the 1970s and 1980s printed money to pay for their socialist policies, only to end up in La Década Perdida. Venezuela, as an extreme example, continued this practice and now has an inflation rate of about 1,000,000%. As a result, there has been a trend of increasing central bank independence across the world, to prevent politicians from using central bank’s policy for their own ends.
In the last decade, many countries have enjoyed low interest rates and inflation and a global savings surplus to accommodate more fiscal expansion, allowing them to implement policies to boost growth. We have written before that this has led to accumulated risks across the global economy, and that governments should increasingly look to improve their economies’ resilience for the next recession. As monetary conditions are now starting to tighten, prudent economic policy and debt issues are becoming ever-more important. In the end, populists will find out that their policies will face binding constraints after all.