Guest Post: More Monetary Quackery

Submitted by Pater Tenebrarum of Acting Man blog,

Central Banks Urged to Drop their 'Fear of Inflation'

An example for the relentless pro central planning and pro inflation propaganda we are regularly confronted with nowadays is a recent editorial at Bloomberg, entitled “Central Banks Must Master Their Fear of Inflation”.  Here is an excerpt from this pro-inflation screed:

“The details get complicated, but the basic reasoning is straightforward. Although nominal interest rates can’t fall to less than nothing, real (inflation-adjusted) interest rates can. To push real short-term interest rates as low as it deems necessary, a central bank merely has to achieve a sufficiently high rate of inflation. (A nominal interest rate of 3 percent is a real rate of 3 percent if prices are expected to be stable, but a real rate of only 1 percent if inflation is expected to be 2 percent.)


In fact, the central bank only has to promise to raise inflation and be believed — that’s enough to change real rates. This is a promise a central bank, and only a central bank, is in a position to make.


Could it therefore make sense for the Federal Reserve to promise, say, three years of 4 percent inflation as a way to drive real short-term interest rates lower? Theoretically, it turns out, the answer is yes. Yet the idea fills most central bankers, raised on the consensus forged in the 1980s, with dread.


The dread is understandable. If higher inflation becomes entrenched, bringing it down again may require a policy-induced recession. Any central banker will tell you that anchoring inflation expectations is vital for economic stability. Few want to be suspected of even considering a controlled dose of higher inflation — in fact many would say there is no such thing.


This thinking is counterproductive. Modern central banks pay lip service to the idea of transparency and insist they want their actions to be better understood. When it comes to discussing the trade-off between inflation and a more rapid recovery, they prefer to look away.


Lately, however, this reluctance has collided with the inescapable reality that, with all the advanced economies growing so slowly, maintaining or increasing monetary stimulus through QE is necessary. At the same time, central banks know that doing QE while promising to keep inflation very low is partly self-defeating.


Which brings us to the important question: As part of a new monetary-policy framework, can central banks openly aim for a therapeutic spell of higher-than-target inflation while containing the danger that the treatment would go too far?


The answer’s unclear, and the central banks’ unwillingness to confront the issue squarely isn’t helping the discussion. Our view is that a new target, tied to nominal incomes or to the level of future prices rather than the rate of inflation, could serve this purpose. (For a more thorough examination of this idea, see this accompanying essay.) There are good reasons to fear inflation. But no one should be so afraid that the subject can’t even be discussed.”

(emphasis added)

The fact that such arguments are forwarded in editorials and by many modern-day economists is simply stunning. Even if one knew absolutely nothing about economic theory and were instead only aware of economic history, one should recoil from such ideas. The very same argument – namely that there is a 'trade-off between growth and inflation', read: inflation can somehow 'create growth' – has for instance been made the members of France's revolutionary assembly in 1789. And for a while it seemed that they were right. These men were not stupid; they thought: 'all we will do is give the economy a brief shot in the arm, until it is revived again, then we will stop'. But then it turned out that they simply could not stop.

They then proceeded to deliver a historical achievement of some distinction: they completely destroyed two currencies in a row, back-to-back (the 'assignat' and the 'mandat'). For a detailed account of that experiment, see “Fiat Money Inflation in France” (pdf) by Andrew Dickson White. This is a text everyone should read – it stands as a monument for the folly of continually trying to 'stimulate' the economy by means of inflation. It also shows how well educated men can, in spite of actually knowing better, easily fall for committing this abject error.

As Ambrose Evans-Pritchard recently remarked quite correctly, the very same fate awaits the Fed and BoE's 'QE' operations. They will never be 'reversed'. In fact, prominent academic economists are making precisely this argument, namely that 'QE' should just be continued forever!

“Columbia Professor Michael Woodford, the world's most closely followed monetary theorist, says it is time to come clean and state openly that bond purchases are forever, and the sooner people understand this the better.


"All this talk of exit strategies is deeply negative," he told a London Business School seminar on the merits of Helicopter money, or "overt monetary financing".


He said the Bank of Japan made the mistake of reversing all its money creation from 2001 to 2006 once it thought the economy was safely out of the woods. But Japan crashed back into deeper deflation as soon the Lehman crisis hit.


"If we are going to scare the horses, let's scare them properly. Let's go further and eliminate government debt on the bloated balance sheet of central banks," he said. This could done with a flick of the fingers. The debt would vanish.


Lord Turner, head of the now defunct Financial Services Authority, made the point more delicately. "We must tell people that if necessary, QE will turn out to be permanent."

(emphasis added)

That the dangerous quack quoted above is regarded as the “world's most closely followed monetary theorist” is shocking, though perhaps not surprising. We have previously discussed the question of central banks canceling the government debt they hold and what to expect from such a move. It doesn't need to be repeated, except to say that it would compound the foolishness of the current path of policy.

One really wonders why people have lately sold gold. It seems to make little sense in light of the widespread mainstream views on what the 'correct' monetary policy should consist of. Monetary cranks abound wherever one looks. The ultimate outcome of all this inflationary experimentation is preordained, so people have every reason to be very concerned about preserving the value their assets. Of course we are well aware that markets can often behave in an irrational manner for extended time periods. In fact, this is what allows astute speculators and investors to make profitable trades, as there are frequently opportunities created by the markets getting it wrong. In this particular case it is still astonishing, considering how blindingly obvious it is in which direction things are currently moving. Mr. Woodford wants to 'scare the horses'. We are wondering why they are not scared yet – but we suspect they will be soon enough.



Michael Dean Woodford, a proponent of 'QE forever' who even wants central banks to cancel the government debt they hold, thus enshrining the inflation of recent years irrevocably.

(Photo via The Washington Post)