• 23/09/2020

The Fallibility of Central Banks


The Economist| February 5 2016

CENTRAL banks have become the most powerful economic actors on the planet. In part, this is because governments have been so reluctant, since 2009, to use fiscal policy to stimulate their economies. In part, also, it is because the powers of central banks are vast, especially since they have discovered the ability to create money via quantitative easing (QE). This gives these undemocratic bodies the ability to redistribute wealth, from savers to borrowers, and from cautious types who keep the bulk of their money in cash to the better-off who own equities and corporate bonds.

At times, you can sense the hauteur with which bankers view lesser mortals. Insomniacs like your blogger may have listened to Ben Broadbent, the deputy governor of the Bank of England, on the BBC’s Wake Up to Money programme this morning (about 30 minutes into the programme). He addressed his interviewers like a headmaster lecturing some dim 14-year olds. In response to a couple of questions, he pointed out that he had dealt with the point on the same programme a year ago (“Haven’t you done your revision, boy?” was the undercurrent). And he batted away a question about the lopsided nature of the British recovery with

Look, what we do, our target is inflation

Indeed, it is. How’s that going? A Martian looking at this chart might struggle to work out that the Bank is aiming for 2%, with 1 percentage point leeway either side. Since the start of 2008, the Bank has been outside that target range in 47 of the 96 months, almost exactly half the time. A Premier League football manager would be sacked with such a record.

Nor would a Martian necessarily have understood the relationship between Bank policies and the inflation target. It conducted QE operations from 2009 to 2012, a period when inflation was consistently above target. It stopped QE at that point, since when inflation has been consistently below target, without any additional stimulus from the Bank.

All this can be explained, of course. First, rising commodity prices were responsible for driving inflation above target from 2008 to 2012 and falling commodity prices brought it back below target from 2013 on. Since this was externally-generated inflation, you could argue that is outside the Bank’s remit.

However, the Bank is targeting CPI which includes this externally-generated element. And its forecasts were consistently wrong. It keeps expecting inflation to return to target at the 18 month-two year horizon. It has to do this, by definition; if it thought inflation would be a lot higher or lower than target, then its policy should change. Still, all the highly-trained economists at the Bank failed to predict the commodity cycle.

Forecasting the economy is very difficult. Fine to admit that, but that raises the question of how useful “forward guidance” is. The concept of forward guidance is that the Bank gives the market an idea of its longer-term expectations for rate moves. Mr Broadbent referred to this in the interview, saying he thought the Bank’s guidance may have helped the recovery. At the same time, he added that guidance never was, nor is it, nor will be a specific promise

This is really having your cake and eating it. If guidance can be changed at every meeting, it isn’t really that much help to someone planning a business. It might be of great help if a businessperson could count on the Bank being great at forecasting inflation but, as we can see, it isn’t.

The second explanation for the Bank’s failure to hit the target is that it was taking into account the general condition of the British economy; it was weak leading up to 2012 and has been stronger since. So monetary stimulus was required in the early years; less so, since 2013. Fair enough, but that suggests the Bank’s is focusing on unemployment and GDP growth. So Mr Broadbent can’t get away with saying the Bank is only targeting inflation.

The record shown in the chart suggests that a bit of humility from the Bank might be in order; a quality that was noticeably lacking from the interview. Indeed, central banks in general might reflect on their failure to foresee the crisis of 2008, rather than cultivating their air of omniscience.

Central banks may be about to get even more power. Martin Wolf of the FT, amongst others, has been speculating that another economic downturn would require more extraordinary measures, such as helicopter money (QE into consumers’ pockets) or the abolition of cash so that negative interest rates can be imposed. The latter is a complete political non-starter in my view; it would be perceived as confiscation (your $100 in the bank is being cut to $99). Helicopter money is a more subtle form of confiscation (on savers, at least) but might have broader appeal (it would seem like “free money” to some). But if it does happen, it has to be a governmental choice. That would be too much power for central bankers to have. As the Bank of England has shown, they are fallible.


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