The inflation problem is only in the minds of central bankers

Yesterday we looked at the trend towards negative interest-rates and today we can link this into the issue of inflation. So let me open with this morning’s release from Swiss Statistics.

The consumer price index (CPI) remained stable in December 2019 compared with the previous month, remaining at 101.7 points (December 2015 = 100). Inflation was +0.2% compared with the same month of the previous year. The average annual inflation reached +0.4% in 2019.These are the results of the Federal Statistical Office (FSO).

The basic situation is not only that there is little or no inflation but that there has been very little since 2015. Actually if we switch to the Euro area measure called CPI in the UK we see that it picks up even less.

In December 2019, the Swiss Harmonised Index of Consumer Prices (HICP) stood at 101.17 points
(base 2015=100). This corresponds to a rate of change of +0.2% compared with the previous month
and of –0.1% compared with the same month of the previous year.

Negative Interest-Rates

There is a nice bit of timing here in that the situation changed back in 2015 on the 15th to be precise and I am sure many of you still recall it.

The Swiss National Bank (SNB) is discontinuing the minimum exchange rate of CHF 1.20 per euro. At the same time, it is lowering the interest rate on sight deposit account balances that exceed a given exemption threshold by 0.5 percentage points, to −0.75%.

If we look at this in inflation terms then the implied mantra suggested by Ben Bernanke yesterday would be that Switzerland would have seen some whereas it has not. In fact the (nearly) 5 years since then have been remarkable for their lack of inflation.

There is a secondary issue here related to the exchange rate which is that the negative interest-rate was supposed to weaken it. That is a main route as to how it is supposed to raise inflation but we find that we are nearly back where we began. What I mean by that is the exchange-rate referred to above is 1.084 compared to the Euro. So the Swiss tried to import inflation but have not succeeded and awkwardly for fans of negative interest-rates part of the issue is that the ECB ( European Central Bank) joined the party reminding me of a point I made just under 2 years ago on the 9th of January 2018.

For all the fire and fury ( sorry) there remains a simple underlying point which is that if one currency declines falls or devalues then others have to rise. That is especially awkward for central banks as they attempt to explain how trying to manipulate a zero-sum game brings overall benefits.

The Low Inflation Issue

Let me now switch to another Swiss based organisation the Bank for International Settlements  or BIS. This is often known as the central bankers central bank and I think we learn a lot from just the first sentence.

Inflation in advanced economies (AEs) continues to be subdued, remaining below central banks’ target
in spite of aggressive and persistent monetary policy accommodation over a prolonged period.

As we find so often this begs more than a few questions. For a start why is nobody wondering why all this effort is not wprking as intended? The related issue is then why they are persisting with something that is not working? The Eagles had a view on this.

They stab it with their steely knives
But they just can’t kill the beast

We then get quite a swerve.

To escape the low inflation trap, we argue that, as suggested by Jean-Claude Trichet, governments
and social partners put in place “consensus packages” that include a fiscal policy that supports demand
and a series of ad hoc nominal wage increases over several years.

Actually there are two large swerves here. The first is the switch away from the monetary policies which have been applied on an ever larger scale each time with the promise that this time they will work. Next is a pretty breathtaking switch to advocacy of fiscal policy by the very same Jean-Claude Trichet who was involved in the application of exactly the reverse in places like Greece during his tenure at the ECB.

Their plan is to simply add to the control freakery.

As political economy conditions evolve, this role should be progressively substituted by rebalancing the macro
policy mix with a more expansionary fiscal policy. More importantly, social partners and governments
control an extremely powerful lever, ie the setting of wages at least in the public sector and potentially
in the private sector, to re-anchor inflation expectations near 2%.

The theory was that technocratic central bankers would aim for inflation targets set by elected politicians. Now they want to tell the politicians what to so all just to hit an inflation target that was chosen merely because it seemed right at the time. Next they want wages to rise at this arbitrary rate too! The ordinary worker will get a wage rise of 2% in this environment so that prices can rise by 2% as well. It is the economics equivalent of the Orwellian statements of the novel 1984

Indeed they even think that they can tell employers what to do.

Finally, in a full employment context,
employers have an incentive to implement wage increases to keep their best performing employees
and, given that nominal labour costs of all employers would increase in parallel, they would able to raise
prices in line with the increase of their wage bills with limited risk of losing clients

Ah “full employment” the concept which is in practical terms meaningless as we discussed only yesterday.

Also as someone who studied the “social contracts” or what revealingly were called “wage and price spirals” in the UK the BIS presents in its paper a rose tinted version of the past. Some might say misleading. In the meantime as the economy has changed I would say that they would be even less likely to work.

Putting this another way the Euro area inflation numbers from earlier showed something the ordinary person will dislike but central bankers will cheer.

Looking at the main components of euro area inflation, food, alcohol & tobacco is expected to have the highest
annual rate in December (2.0%, compared with 1.9% in November),

I would send the central bankers out to explain to food shoppers how this is in fact the nirvana of “price stability” as for new readers that is what they call inflation of 2% per annum. We would likely get another ” I cannot eat an I-Pad” moment.


Let me now bring in some issues which change things substantially and let me open with something that has got FT Alphaville spinning itself into quicksand.

As far as most people are concerned, there is more than enough inflation. Cœuré noted in his speech that most households think the average rate in the eurozone between 2004 and last year has been 9 per cent (in fact it was 1.6 per cent). That’s partly down to higher housing costs (which are not wholly included in central banks’ measurement of inflation).

That last sentence is really rather desperate as it nods to the official FT view of inflation which is in quite a mess on the issue of housing inflation. Actually the things which tend to go up ( house prices) are excluded from the Euro area measure of inflation. There was a plan to include them but that turned out to be an attempt simply to waste time ( about 3 years as it happened). Why? Well they would rather tell you that this is a wealth effect.

House prices, as measured by the House Price Index, rose by 4.2% in both the euro area and the EU in the
second quarter of 2019 compared with the same quarter of the previous year.

Looking at the situation we see that a sort of Holy Grail has developed – the 2% per annum inflation target – with little or no backing. After all its use was then followed by the credit crunch which non central bankers will consider to be a rather devastating critique. One road out of this is to raise the inflation target even higher to 3%, 4% or more, or so we are told.

There are two main issues with this of which the first is that if you cannot hit the 2% target then 3% or 4% seems pointless. But to my mind the bigger one is that in an era of lower numbers why be King Canute when instead one can learn and adapt. I would either lower the inflation target and/or put house prices in it so that they better reflect the ordinary experience. The reason they do not go down this road is explained by a four letter word, debt. Or as the Eagles put it.

Mirrors on the ceiling
The pink champagne on ice
And she said: “We are all just prisoners here
Of our own device”


20 thoughts on “The inflation problem is only in the minds of central bankers

  1. Hello Shaun,

    radio 4 has a quiz game called ” I’m sorry I haven’t a clue ”

    the CB’ers must be the panelists……….


  2. Excellent piece Shaun. As you say, the CBs have been trying the same policies for years and not achieving their spurious targets, so why continue? Is any of them thinking of trying something new, instead of just tinkering with the same old.
    I am sure the new governors of the B of E and the ECB are going to come up with some radical solutions!!! Ha Ha

    • Hi Foxy and thank you

      Well we do have changes at the Bank of England and ECB as you say. But neither has any expertise in monetary policy nor much sign of intellectual flexibility. In fact both have records mostly made up of failures. Thus I expect more of the same just like you.

  3. Hi Shaun

    Happy new year and a great article as always.

    Well I’ve started the new year with an inflationary shock in manchester. The bus fares have risen 30% and their excuse:

    ‘With this in mind, we’re proud to introduce our new, simpler range of tickets ‘

    And the tram ticket has risen 5%. The tram passes are now rivalling tube passes from when I lived in London. Although in London you could use the train/bus etc.

    I wonder if these will filter through into the inflation measure.

    • The amount of fare dodging in London is staggering. Certain stations I could mention regularly have people dashing through behind someone with a valid oyster. It saves a lot of money though. A return journey is often over 6 pounds which is more than the cost of day’s worth of food. London travel is cheap compared to say Merseyside or greater Manchester.

      Even if you switch to riding a bike it can cost almost as much. The wear and tear on a bicycle if ridden 10 plus miles a day is significant and even if you have the tooling, knowledge and time to repair yourself it is still significant.
      Only if you can walk can you truly save.
      In my experience the cost of travel is the second most expensive thing after rent/mortgage.
      How accurately this is captured by inflation measures is debatable.

  4. Shaun, this sentence is fantastically naive: “. . . given that nominal labour costs of all employers would increase in parallel . . .”. It’s not even believable in an ivory tower sense. Wow!

  5. Shaun

    “There are two main issues with this of which the first is that if you cannot hit the 2% target then 3% or 4% seems pointless. But to my mind the bigger one is that in an era of lower numbers why be King Canute when instead one can learn and adapt. I would either lower the inflation target and/or put house prices in it so that they better reflect the ordinary experience. The reason they do not go down this road is explained by a four letter word, debt. Or as the Eagles put it.”

    To my mind the bankers need to balance some inflation to deflate the massive amount of debt the world is carrying without it getting out of hand and damaging the economy.

    So they plumb for 2% if it went any lower the danger is it will be missed and then we enter deflation.

    You are correct in your analysis “debt” is the problem!

    To deal with an earlier point in respect of lower interest rates should increase inflation one could argue that lower interest rates are a result of forecast lower inflation!

    If one accepts the above premise then negative interest rates would follow lower inflation and also deflation.

    • As for house prices forecasts are for quite health rises in the UK the next five years according to this article:

      All this will depend on a stable economy however and if the situation in IRAN fires off big time and oil spikes its back to the drawing board.

      Mind you the US is big on shale gas now and that makes a big difference to oil demand. As for the UK I believe we now produce 50% of our utilities by wind or renewables now and we are heading in the right direction to be less reliable on oil.

      Quite how someone can forecast the next five years beats me, the election results in the UK surprised most and no one has a crystal ball.

      • Hi Peter

        There is more than a little moral hazard in the experts selected by the Daily Mail.

        “Miles Shipside, Rightmove director and housing market analyst,
        Lucian Cook, head of residential research at Savills
        Andrew Harvey, Nationwide’s Senior Economist, said: ”

        So they are likely to forecast as much as they think they can get away with.

        I can help a little with the UK wind data from 45 minutes ago/

  6. Great blog as usual, Shaun.
    The UK, the first European country to adopt an inflation targeting regime for its central bank, began in 1992 with a long-term inflation target range of 0% to 2%, which implied a 1% target rate. This was also the target range announced by New Zealand Finance Roger Douglas in 1988 when New Zealand introduced inflation targeting to the world. Bank of Canada Governor John Crow favoured a 1% target rate for the initial renewal of the inflation-control agreement with the Government of Canada, and if there had not been a change in government, he might well have negotiated that rate. Maybe instead of asking why advanced economies can’t hit 2%, BIS economists Luiz A Pereira da Silva and Benoît Mojon might ask themselves why they would choose to define price stability at such a high target rate, about double the target rate that the first advanced economies to adopt inflation targeting regimes seemed to have in mind when they initiated those regimes.
    I notice that the BIS economists see their proposal as an alternative to raising the target rate to 2% via helicopter money. They write: “The major common risk of such extreme cases of unconventional monetary policy is that their impact on inflation is not precise enough to reach central banks’ targets at the desired objective of, say, 2%. That is due essentially to the transmission of such large-scale experiments through aggregate demand in ways that, once unleashed, would be difficult to control or reverse if need be.” Just the same, helicopter money has its strong advocates, and one of them, Jean Boivin, could be the next Bank of Canada Governor, taking over from Stephen Poloz in June.
    Happy Orthodox Christmas to all of the Orthodox Christians who read your blog. Hristos se rodi!

    • Hi Andrew and Happy Orthodox Christmas to you too

      It is really quite extraordinary that central bankers can think they can get away with intervening on a grand scale without any great success and assume they will bee trusted again. But yet another example is around tonight as your countryman and our Governor is given free licence by the Financial Times.

      Er, who fired the ammunition?

      Returning to the subject it is amazing the UK tried to start with a 1% inflation target. I guess joining the “ERM” after shadowing the German DM went to our heads. But times change and lowering the target by another route ( adding house prices) would be a clear improvement.

  7. Hi Shaun

    I think you summed it up nicely in your penultimate sentence: debt. Inflation is the soft default of choice; the get out of jail (almost) free card that would at least make some inroads into resolving the debt overhang.

    But have we gone too far already? Debt has increased hugely in the last ten years and risk has climbed enormously. Even at low commercial rates many companies and individuals need only a minor change in circumstances to push them into insolvency. We don’t need a recession to bring the pains on in many cases; just a small fall in aggregate demand is enough to ensure that debt can’t be serviced, let alone repaid.

    The inflection to fiscal policy is, as you say, a recognition that monetary policy has ceased to work and should take over some of the heavy lifting.. The thing is of course is what is actually wanted is inflation without the consequences, the consequences being higher rates, which will puncture the bubble and higher inflation that will give a twist to public spending that is subject to escalation. Of course once you analyse these things you discover that there is no free lunch as they say and it becomes a case of choosing the least worst option.

    • Bob,I think the plan is for governments to take the baton from central banks and borrow and spend for the fiscal stimulus, with the central banks doing QE to prevent interest rates from rising, will it work? We are soon going to find out, but inflation is going to be uncontrollable once it takes off.

      • re ” inflation is going to be uncontrollable ”

        no , they will do what they do now , not measure it . or replace it with a ” happyness ” index………. I kid you not !


  8. Pingback: The inflation problem is only in the minds of central bankers – Investment Watch | Bear News

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