Central Banks: Blundering Masquerading as Policy

ECONOMIC PERSPECTIVES – 55

Emile Woolf, Going Postal
The Eccles Federal Reserve Board Building in Washington, D.C. houses the main offices of the Board of Governors of the United States’ Federal Reserve System CC Licence

A couple of months back, in the context of blaming the government’s inflexibility for its failure to achieve a deal with the EU over Brexit, Jeremy Corbyn railed against the Tory Party, declaring that it “actually wants to turn this country into a deregulated, low-tax society that will do a deal with Trump.”

If only! What Corbyn identified as a curse would be recognised by any sane economist as a blessing: an aspiration for any worthy new leader in the present vacuum of ideas called Westminster.

A long-overdue recession?

There is now a global economic slowdown that even benighted statisticians are picking up on their radar screens and, predictably, incumbents of high office everywhere are ready with their excuses, blaming anything except their own policies for the decline that now confronts them.

What passes these days for economic policy-making is merely a re-enactment of sticking plaster expedients that have previously been tried to destruction by politicians too blind to see economic causes behind economic effects.

To take a current example, central banks everywhere dread a fall in prices as the principal threat to economic well-being, believing that they should permanently “target” a 2 per cent inflation rate as the panacea for any slowdown.  This is a blanket view that takes no account of the reasons for such a fall. Their reaction to falling price levels is simply that it implies an accompanying fall in demand, and they blame “hoarding” (savings), or “uncertainty” among available culprits.

If, indeed, it is the case at a point in time that people generally prefer holding on to money rather than spending it, market forces will soon enough lead to a fall in prices and a restoration of demand. Alternatively, if there is a glut in supply, such as that caused by the recent Brexit stockpiling hysteria, any resulting fall in prices will be followed by an increase in demand.

Market interference

But the natural function of markets is always dogged by central banks’ refusal to see that a fall in the general price level could be a natural result of their own policies, slavishly followed by the treasuries they are supposed to serve – such as the deliberate suppression of interest rates over a sustained period, leading in turn to (i) mispricing of risk and capital losses for businesses; (ii) an excessive amount of low-grade cheap lending and a rising level of defaults; and (iii) wholesale withdrawal of savings and their reinvestment in funds with a higher return, but a later redemption date.

All this arises from that old Keynesian myth: aggregate demand is the catalyst that must somehow, anyhow, be given a boost in order to get the engine of growth going again.

This disastrous notion completely ignores economic reality: it is production, rather than demand, that holds the key. In a business environment that encourages business by, say, instituting a low-tax regime and dismantling the web of wasteful and unnecessary regulations (all of which would be utterly antithetical to the Marxist thinking of comrade Corbyn and his acolytes) we would certainly not need to worry about demand: it will quite naturally find satisfaction in acquiring the lower-priced products that would then be available.

There’s certainly nothing to fear from a price reduction that follows a removal of obstacles to production – but try to get politicians to see it that way!

No, what their advisers want is the very opposite – an increase in prices by a nice round two per cent per annum. That’s the targeted magic number: TWO. Not three, not one-and-a-half. It hasn’t been “calculated”, of course, not even by the statistical nuts in the Treasury, because it’s based on, well…….. a feeling; a “feel-good” feeling, would you believe!

Tripe, from the top!

You probably don’t believe me. So here – try this for yourself. Here is a direct quote from Jerome Powell, Chairman of America’s central bank, the Federal Reserve, in February this year: “We’re trying to think of ways of making that inflation 2% target highly credible, so that inflation averages around 2%, rather than averaging 2% in good times and then averaging way less than that in bad times.”

Have you ever heard such drivel? From people who are directing the economy of the world’s wealthiest nation? You can even follow it up by listening to that treasure house of economic pearls, the Wall Street Journal, advocating that the Treasury should send a signal to the markets “as a way of convincing the public that the Fed is serious about making sure it will meet its 2% inflation target. Fed officials seek 2% inflation because they see it as consistent with healthy growth”.

What they don’t see, or even acknowledge, is the reality of the Fed’s policy: the destruction of the purchasing power of the dollar at the seemingly innocuous rate of doubling prices every 35 years – mild, you might think, compared with some even more dedicated counterfeiting jurisdictions? But central banks don’t even know how to measure the rate of inflation, let alone control it.

In any case, what they call “inflation” is merely an increase in prices, forgetting that an increase in prices could have a number of possible economic causes – including inflating the money supply. Yet, to the Fed and the other central banks, these causes are indistinguishable. All they seek is a rise in prices at their “target” rate of 2% per annum, and they stamp their feet in frustration when its attainment proves so disobliging!

Because of their deeply held belief that (i) what matters most to an economy is demand and (ii) by fiddling around with interest rates and inflation “targets” they can control demand, the focus of central banks remains fixed on this false god.

An alternative strategy

Despite the prevailing obduracy of Treasury thinking, there are lessons to be gleaned – even from the USA. Despite his utterly unprincipled, potentially lethal trade policies, President Trump’s administration has overseen a huge boost to the American economy by instituting radical tax cuts. The headline corporate rate of tax was slashed from 35 to 21 per cent, a move that has undoubtedly stopped American companies from shifting resources abroad and, instead, reinvesting their savings in domestic production. This has been accompanied by a wide-ranging simplification of the USA’s unbelievably complicated tax code – its most significant reform in 40 years.

Then deregulation. The Trump administration has introduced 40 per cent fewer rules than either of its two predecessors at the same stage – and almost 1,600 regulations from the Obama years have now been scrapped! An enormous boost to business confidence has followed – a feature that will be lost on this week’s protesters against Trump’s visit to Europe.

Finally, Trump has made it clear that central bank independence is by no means sacrosanct. The Fed – having presided over an unprecedented tally of asset bubbles; the worst recession in modern times; and the unbridled destruction of its currency’s purchasing power – is a target for drastic reform. Don’t be surprised to see its wings severely clipped. We live in hope.
 

© Emile Woolf May 2019 (website)
 

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