There are two potential explanations for the recent hawkishness of global central banks.
The first is that central banks had realised that their policy of monetary easing on a massive scale hasn’t been helping. Instead, it has discouraged investment, encouraged recklessness and driven a further accumulation of credit and mispricing of assets. This has resulted in a huge misallocation of resources.
The second possible explanation is more worrying. This is that the world’s central banks have renewed their faith in the same old broken macroeconomic models which created the global financial crisis and then papered over the cracks that appeared in its aftermath.
It pains me to say that the second explanation has proved correct. Once again, Janet Yellen has broken my heart. This time, she did it simply by uttering the words "watching inflation closely". Having raised interest rates a couple of times this year despite some near-term softness in inflation (which she described as "transitory") Yellen has presumably been pushed too far by the latest soft inflation figures. Yes, in the 12 months to end-June, the year-on-year consumer price index (CPI) was revealed to have risen by just 1.6%!
Let’s put aside the fact that the world’s central banks have proven themselves worse than inept at forecasting inflation. Let’s ignore, too, the fact that many of the prices that make up the CPI are decided in other countries or on global exchanges and are therefore irrelevant to the policy framework. And we definitely shouldn’t lift the hood and delve into the theoretical models used to justify our dogmatic and damaging obsession with consumer-inflation indices. If we did, we might discover a lack of theoretical - let alone empirical - justification for the relevance of 2% or the ability of central banks to manage inflation.
A few weeks ago, I had dinner with a sitting member of the Federal Open Markets Committee. He made an excellent point about inflation-targeting at the Federal Reserve (Fed): how is it that the Fed has a single inflation target with zero tolerance for deviation, when the only tool it has to achieve this target is a federal funds rate that it can’t even control to a specific value? The fed funds target, as issued by the Fed, continues to be a 25-basis-point range. Fed officials can’t be sufficiently precise to hit an actual figure – not least because of all the liquidity they have pumped into the system.
But none of that matters. What we are seeing is dogmatism, pure and simple.
If this tirade sounds even more bitter than usual, that’s because it is. I am struggling with the Fed’s behaviour because in July, to compound matters, other central banks made very different choices. It turns out that you cannot use the same analysis to justify or predict the behaviour of different central banks. I have come to believe that central banks take on the personalities of their governors – and this rather defeats the purpose of having monetary policy committees.
The result of the Fed’s renewed anxiety about inflation was a rally in Treasury yields, but also – and more importantly – a further decline in the value of the US dollar. Yes, the biggest, most advanced, most closed, least export-reliant economy of them all now has a currency that is pretty close to being in freefall. I don’t think this helps, because I don’t think it reflects the realities of economics or policy. What it does is encourage a further liquidity-driven ‘grab for yield’. At some stage, this will end in tears – when the metaphorical punchbowl is finally withdrawn.
But for now, with Yellen afraid to look beyond tomorrow and Trump becoming a caricature of his caricature, the dollar washout continues. Even when the Reserve Bank of Australia explicitly told investors that they were misreading its minutes and had thus been buying the Aussie dollar under false hopes, the market cared not a jot. Because the US dollar is weak, you buy carry. Especially when it’s summer. What could possibly go wrong?
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