If Central Banks wanted to make a positive impact on the global economy, they would abolish themselves and let the free market set rates.
Instead, and after pursuing a 2% inflation target for decades, central bankers now ponder the need for even higher rates of inflation.
Rethinking Made Worse
Please consider Rethinking the Widely Held 2% Inflation Target.
Inflation has finally returned to the Federal Reserve’s 2% goal after undershooting it for nearly five years. Now, just as the central bank has inflation where it wants it, economists and central bankers are starting to think the goal, and how it has been implemented in many places, was a mistake.
Spooked by inflation spikes during the 1970s and early 1980s, central bankers had come to view targets as a core tenet of sound monetary policy. In the 1990s and 2000s, many picked a 2% target, seeing it as not so high that it would disrupt business decisions and wage negotiations, and not so low that it would make interest rates unmanageable.
Today, after a long period of exceptionally low inflation and interest rates, central banks are talking about alternatives to rigid 2% targets. Many of these alternatives involve the option of letting inflation rise above 2% either permanently or for a time.
“This is one of those ideas that has moved from a crazy idea that no one would discuss to an idea that is being seriously discussed by important policy makers,” said Emi Nakamura, an economist at Columbia University.
The financial crisis and its aftermath shifted the consensus. Instead of high inflation, today’s central banks are confronted with aging populations, lower long-term growth and higher saving rates. Those all hold down the real natural interest rate—the equilibrium interest rate, adjusted for inflation, that keeps borrowing, lending and the broader economy in balance.
A very low natural rate is a problem for central bankers, who manipulate short-term interest rates to manage their economies. When the economy heats up, they push rates higher to slow it down. When the economy slows down, they cut rates to speed it up.
When the natural rate is very low, central banks risk running rates into zero when they’re trying to cut, effectively running out of room to stimulate the economy in a downturn. New research by Fed economists Michael Kiley and John Roberts suggests Fed officials may now confront near-zero interest rates 40% of the time or more because of the low natural rate.
Olivier Blanchard, an economist at Peterson Institute for International Economics, kicked off the debate over higher inflation in 2010 when he suggested a 4% target while serving as the International Monetary Fund’s chief economist. The idea was that a steady rate of higher inflation would mean that nominal interest rates could be higher too, leaving central banks more room to cut in a downturn to boost output.
The blatant nonsense inherent in the above article is apparent in one second flat, just by looking at the chart.
The natural interest rates can never be negative. Here’s why: A negative rate implies things like one would rather have 90 cents tomorrow than a dollar today.
That’s illogical. Rather than accept negative rates, one could simply sit on money.
Don’t confuse negative natural rates with storage charges for safe keeping. Storage charges are a service fee, not a natural interest rate.
Also, the idea the Fed or anyone else can divine the natural rate is in and of itself preposterous. The free market could, not a collective bunch of self-appointed economic wizards.
Finally, these self-appointed wizards not only think they can determine the natural rate, they arrogantly believe they know when to override that rate.
Economic Challenge to Keynesians
Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.
I have commented on this many times and have been vindicated not only by sound economic theory but also by actual historical examples.
My article Deflation Bonanza! (And the Fool’s Mission to Stop It) has a good synopsis.
And my Challenge to Keynesians “Prove Rising Prices Provide an Overall Economic Benefit” has gone unanswered.
There is no answer because history and logic both show that concerns over consumer price deflation are seriously misplaced.
The BIS did a study and found routine deflation was not any problem at all.
“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the BIS study.
It’s asset bubble deflation that is damaging.
And in central banks’ seriously misguided attempts to fight routine consumer price deflation, central bankers create very destructive asset bubbles that eventually collapse.
When those bubble burst, and they will, it will trigger debt deflation, which is what central banks ought to fear.
For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?
Meanwhile, economically illiterate writers bemoan deflation, as do most economists and central banks. The final irony in this ridiculous mix is central bank policies stimulate massive wealth inequality fueled by soaring stock prices.
Challenge to John Williams
I challenge John Williams to a debate on interest rate policy. All proceeds will go to charity. Of course, Williams would never agree to debate me.
Confused About Safekeeping?
For a discussion of the difference between safekeeping charges and negative interest rates, please see Confusion Over Negative Interest Rates; What About Safekeeping Fees?
Mike “Mish” Shedlock