The Federal Reserve, the European Central Bank and the Bank of England all preside over inflation rates that have surged to quadruple their 2% targets. One of their brethren is highly skeptical of their chances of success in calming price increases. It may turn out that they’ve been lucky rather than good in achieving price stability in recent years — and their luck has run out.
A few weeks ago, Jeremy Rudd, a senior economist at the Fed, published a paper that does little to inspire confidence in the ability of policy makers to prevent stagflation from afflicting their economies. Moreover, one of his conclusions — that anchoring inflation expectations has little effect on prices — suggests the current mania among central bankers for raising interest rates may exact a cost on growth without a corresponding benefit of achieving their chief policy goal.
Rudd examined a surge in US inflation in the second half of 1960, noting parallels between then and now. It’s his assessment of what’s been learned in the intervening period — or rather, what remains unknown — that’s most striking:
Perhaps the most sobering fact, though, is how little practical benefit six decades’ worth of additional experience has provided us: Our understanding of how the economy works — as well as our ability to predict the effects of shocks and policy actions — is in my view no better today than it was in the 1960s.
The current bout of rising prices has certainly caught today’s central bankers napping. Figures last week showed consumer prices in the euro zone rising at a record pace of 8.1% in May, up from 7.5% in the previous month and faster than the 7.8% anticipated by economists. In the UK, the Bank of England expects inflation to surpass 10% in the coming months. And economists expect the US to post its fourth consecutive increase of more than 8% on June 10.
It’s understandable, if not forgivable, that the forward guidance policy makers are currently delivering is all over the place. “For me, I think a pause in September might make sense,” Atlanta Fed President Raphael Bostic said on May 23. Contrast that with Fed Governor Christopher Waller’s comments last week that “I support tightening policy by another 50 basis points for several meetings,” and the path for at least the next three US central bank decisions is as clear as mud, as Jim Bianco of Bianco Research alluded to in a tweet.
ECB President Christine Lagarde has attempted to give financial markets clarity about what her institution is planning, committing last month to raising interest rates by a quarter-point in July and again by the end of the third quarter. That would bring the bank’s deposit rate to zero, up from -0.5%.
But both Dutch central banker Klaas Knot and Slovakian policy maker Peter Kazimir are refusing to rule out half-point increases, while Austrian central bank chief Robert Holzmann said on Friday that “a 50 basis-point rise would send the necessary clear signal that the ECB is serious about fighting inflation.”
Given the surge in last week’s inflation print, Lagarde could find herself outflanked by the hawks on the governing council in the coming months, even if the self-imposed desire to halt bond purchases before raising borrowing costs means this week’s decision probably remains a non-event.
Rudd’s April 9 research note echoes a paper he published in September in attempting to debunk the notion that expectations are drivers of inflation, a proposition he called “arrant nonsense.” His more recent work calls into question how effective policy makers can expect to be in reacting to unforeseen — and arguably unforeseeable — shifts in the economy:
Perhaps the most useful lesson from the 1960s inflation experience is how difficult it is to successfully conduct economic policy in the real world and in real time. Policymaking unfolds on a ‘darkling plain,’ and its practitioners—as well as those who seek to advocate an alternative course—will invariably be burdened by a highly imperfect understanding of how the economy works; noisy and revision-plagued data; and outcomes that cannot even be specified in advance, let alone be assigned a credible probability weight. Of course, policymakers face an additional burden that these others don’t: They are the ones responsible for making consequential decisions, and they are the ones held accountable for the results.
If major economies do slump into stagflation, policy makers will have failed to do their jobs. Nevertheless, as tempting as it might become for some politicians, questioning their independence to set monetary conditions would be the wrong reaction.
Bloomberg
