Money, Banking, and International FinanceOn the other hand, profits do not guide the government agencies, and no mechanism keeps a
government agency in check. Every year, government agencies receive more funding, regardless
of the agencies’ performance. Over time, bureaucrats become more concerned with funding, job
security, and prestige, instead of following its original function. This explains why the public
poorly rates its dissatisfaction of government agencies. Principal-agent view for the Fed is the
chairman worries over his or her own self-interest and protects his friends, such as the large
commercial and investment banks.
The Fed is independent of the U.S. Treasury Office, even though some Presidents tried to
influence it. However, a government budget deficit could lead to money creation. If the Fed
maintains a constant interest rate, and the U.S. government operates a budget deficit, the U.S.
Treasury department can finance the deficit by issuing T-bills. Nevertheless, the T-bill supply
rises, causing the market price of T-bills to fall. Thus, market interest rates rise. If the Fed
maintains a fixed interest rate, it must buy the T-bills the Treasury issued, expanding both bank
reserves and money supply. Consequently, a government budget deficit leads to inflation if a
central bank focuses on the interest rate.
Foreign countries differ in their degree of independence between government and their
central banks. For example, the Eurozone and Switzerland have the most independent central
banks in the world. Thus, these countries experience the lowest inflation rates in the world. On
the other hand, the central banks in Russia, Kazakhstan, Thailand, and Turkey have less
independence from their governments, and these countries experience greater inflation rates.
A national government’s financial health determines the level of independence between the
government and the central bank. Political leaders boost government spending to win favors
with the public, but hesitant to raise taxes. Consequently, a government would suffer from a
budget deficit that its treasury can finance by selling government bonds. As a government’s debt
continually grows, investors will reach a point when they stop buying bonds. Unfortunately,
political leaders refuse to cut government programs and subsidies or raise taxes. Only solution is
the government forces its central bank to buy its bonds that investors do not want, even though it
creates inflation.
Many Americans and experts believe the massive $17 trillion U.S. government debt will
lead to inflation as the U.S. government forces the Federal Reserve to buy its bonds.
Subsequently, the Federal Reserve would lose its independence.
The European Union experienced a similar situation. Greece, Spain, Ireland, and Portugal
reached their debt limits, and investors no longer want to buy these governments’ bonds. The
European Central Bank is independent of the member countries’ governments, and these
countries cannot force the central bank to buy their bonds. Instead, the governments imposed
austerity measures, where they increased taxes and reduced government programs and subsidies,
sparking massive protests and demonstrations against the governments. Furthermore, increasing
taxes or decreasing government spending hinders economic growth. Consequently, many
European countries had entered a recession in 2012.
The Greek government cannot control its budget deficit, and it forced bonds holders to take
a huge loss on the Greek bonds in 2010. Consequently, Greece lost its investors, and it will
likely leave the Eurozone and reintroduce its currency, the drachma. The Greek citizens and