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Category: Soap Box

Soapbox: Central bankers are fresh out of ideas

Enter the big guns. The International Monetary Fund (IMF) has told the Bank of England (BoE) that it should put up interest rates (which have been at...

16 December 2021

Gary Mead

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Enter the big guns. The International Monetary Fund (IMF) has told the Bank of England (BoE) that it should put up interest rates (which have been at 0.1% since 19 March 2020 ) to choke off inflation which, the IMF says, will rise to 5.5% early in 2022. The IMF looks to be behind the curve as usual.

For inflation in the UK has already reached 5.1%, in November. The IMF also forecast that inflation will only return to the BoE’s inflation target of 2% two years after that. If we look at the retail price index (RPI), which the UK government ditched in 2011 in favour of the consumer price index (CPI) because the RPI allegedly over-stated inflation, then inflation is running at more than 7%, the highest (on this measure) for more than 30 years.


So UK consumers face another two years – at least – of their purchasing power being even more eroded than the official target would imply. The Pound in your pocket will buy 5% less than it would have done at the start of 2021. Buying a house became more expensive; in the UK, average house prices slowed in October according to the Office for National Statistics, but it still rose by 10.2%.

The BoE’s quantitative easing programme means that by the time the programme winds up, at the end of December, it will have bought government and other bonds to the tune of £895 billion. The BoE said this QE was to signal that it would keep inflation on its 2% per year target ; so it’s clearly been a dismal failure. Not that anyone at the Bank will have the honesty to admit that. The Monetary Policy Committee of the Bank is in charge of the QE programme but trying to decipher what it thinks QE is doing has been compared to trying to understand the Enigma machine, the German military cipher machine of the Second World War.

Brits should count their blessings. Their living standards are falling but not as severely as in the US, where inflation in November rose 6.8% from a year ago, the biggest 12-month move since 1982.Your Dollar will by the end of this year buy you almost 7% less than at the start of 2021. Even if the rise in food and energy bills are stripped out, the US consumer price index in November still rose by 4.9%, the biggest rise in 30 years.

Inflation has returned, everywhere; the official figures show it’s now 8.8% in Estonia, in Belgium it’s more than 5%, in Germany it’s above 5% as it is in Norway, in Russia 8.4%, 10.3% in Ukraine, 35.7% in Iran… the list goes on. Let’s not even talk about Argentina, Turkey, Venezuela. In the Eurozone, inflation has reached a record 4.9%. More than three-quarters of countries analysed by Pew Research had higher inflation in the third quarter of 2021 than in the same period in 2019. Official figures are dry, abstract – they don’t capture the pain and anxiety caused by being in a job where wages fail to keep pace with ever-increasing costs of living.

The inflation targets central bankers set for themselves have been blown apart. Their political masters want them to ‘do something’ and fast, otherwise voters will soon drift to another party which will promise them salvation – no matter how flimsy that promise might be. In the UK, Prime Minister Boris Johnson’s approval rating is the worst it has ever been ; the same is true for US President Joe Biden. Biden faces important mid-term elections in 2022; if his Party is then trounced (as it currently looks like being) his Presidency will be consigned to the waste bin marked “lame duck”. Johnson, after a slew of embarrassments, is facing growing rebellion from within his own Party, never mind voter disenchantment.

Are central banks fresh out of ideas? Do they really know, for example, what is causing the current outburst of higher prices? Before you can treat a disease, you need to have a reasonable idea of what is causing it. The consensus among them is that the current inflation wave is ‘transitory’, the definition of which has morphed from being a few weeks, to a few months, to simply ‘not forever’.

Transitory turns durable

The trouble for Biden, Johnson and other political leaders who depend on electorates is that this year’s inflation will soon be next year’s.

In the US, the official inflation figure in any case disguises much higher price rises for particular goods. The energy index, the government’s measure of the prices Americans pay for gasoline, heating and other energy – has soared 33.3% over the past year. Meat, poultry, fish and eggs are all nearly 13% more expensive than this time last year. Farmland prices in the US have soared this year. The average value of an acre of farmland in Iowa has gone up by almost 30% in 2021, according to Iowa State University’s (ISU) annual survey. That has little to do with supply-chain bottlenecks.

The real significance of inflation is not in the prices of things going up – but lies in the fact that the purchasing power of your money is going down. In the UK, spring will see energy bills zoom higher for millions, as the prevailing price cap has been based on wholesale energy prices between August 2021 and January 2022, and these prices have risen by an astonishing 250% in recent months.

Central bankers have very few weapons to use in these situations. When inflation arrives the assumption is that, to use a cliché, “there is too much money chasing too few goods” (and services). Yet it is more complex this time, thanks to the COVID-19 pandemic and the more or less universal lockdowns imposed to control its spread. COVID-19 limited the supply of goods, as people were forced to stay home, not go out to work, not transport goods, not churn out the plastic gizmos that fill Christmas stockings.

Those lockdowns created all kinds of supply-chain bottlenecks, pushing up the cost of containers, pushing up the prices of goods those containers carry, yo-yoing international crude oil supply and demand, throwing employment figures into turmoil, creating a field day for economic forecasters and driving the hunt for a return, for yield – which is one reason why cryptocurrencies have soared, along with equity markets.

And now Omicron, the latest Covid ‘variant’, has thrown a spanner in the works and made tackling inflation more problematic. The World Health Organization (WHO) scarily said towards the end of November that half a million people in continental Europe could die by March unless more urgent action is taken. In Britain, health experts are forecasting a Covid contagion tsunami by Christmas; hospitality venues are facing mass cancellations of celebratory dinners; workers are going down like ninepins; and no government support packages are available this time round. In November the German health minister, Jens Spahn, said that “more or less everyone in Germany will be vaccinated, cured or dead” by the end of the winter given the current rate of the virus’ spread. Across Europe countries have variously re-imposed lockdowns, curfews, mask or vaccine mandates – all of which will impede economic recovery. In the US, Apple is making mask-wearing a requirement for customers visiting its stores. Maybe these strictures are necessary; but they make it more difficult for central bankers to start raising interest rates, simply because they weaken already fragile economies.

A delicate balance

What will the US Federal Reserve do to combat inflation? Jerome Powell, chair of the Fed, has reiterated for much of this year that his view is that inflation is ‘transitory’. He and Janet Yellen, US Treasury Secretary, have brushed aside suggestions that inflation might linger for longer. That is now contradicted by the evidence – US wholesale prices went up by nearly 10% in the 12 months to November; this increase will undoubtedly feed into retail prices in the months ahead. The eyes of the world have been on Powell this week; the faster winding-down of the Fed’s QE bond-buying programme, cutting its purchase by $30 billion a month so that this ‘stimulus’ ends by April was widely expected.

But a rise in US interest rates is not expected before April/May 2022. Powell and President Joe Biden are both reluctant to push up rates too quickly, for fear that would halt the recovery from the Covid damage, even though all the signs are that the economy is on its strongest footing for some time; the unemployment rate has fallen to 4.2% and economic growth this year will be more than 5%.

So we enter one of the most festive periods of the year in a cloud of uncertainty, made even more uncertain by central bankers being fresh out of ideas how to put a halt to the biggest threat to our fiat currencies’ purchasing power for almost 40 years. Act too fast and maybe the economic recovery will grind to a halt; act too slowly and the risk is that inflation will stick around and worsen; stagflation may still be on the cards.

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