The interest rate policy of the US Federal Reserve has again moved into focus. After all, the well-being and woe of the global economy and capital markets depends on interest rates not being raised significantly. Is that really the case?

65 years ago, US government bond yields were at a similar level to today. In order to enable the financing of the burdens from the Second World War, the US Federal Reserve had fixed the interest rate for government bonds at 2.5 percent. But during the Korean War, it became clear that this was not a recipe for maintaining price stability. There were bitter disputes between the Federal Reserve and the US Treasury. The politicians feared for the favourable source of finance and made it quite clear who was the master of the house. In addition, they argued that the FED should keep an eye on investors' positions and protect them from potential price losses. The confrontation reached its peak when US inflation climbed to 21 percent annualized in February 1951. In order to keep the interest rate at 2.5%, the central bank was forced to buy huge amounts of bonds and thus inflate its balance sheet, "This policy," warned central bank head Marriner Eccles, "turns the entire banking system into an inflation machine.

In March 1951, the Ministry of Finance gave in and signed the Treasury-Federal Reserve Accord. This made the bank independent of political pressure and free in its monetary policy decisions. This was the beginning of the modern federal reserve system and the prerequisite for a free market in US government bonds. (You can find the whole story at: www.richmondfed.org/-/media/richmondfedorg/publications/research/economic_quarterly/2001/winter/pdf/hetzel.pdf)

Today the central banks seem to be slaves of politics and the capital markets again. Wouldn't it be time to free yourself again? Instead, the ECB is expanding its bond purchase programmes. On 21 June, the Federal Constitutional Court will now decide whether the ECB exceeded its mandate in 2012 when it announced that it would buy unlimited government bonds from crisis states if necessary. We are curious. Although the ECB does not buy indefinitely, it will still hold 17 percent of all European government bonds in 2017. Maybe the judges will take a look at the history books.

Sincerely,

Klaus Meitinger
Chief Editor

Moritz Eckes
Publisher

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