A persistant refrain by central bankers over the past few years has been how monetary policy should work in accordance with a mandated 2% target for inflation. This target – which differs slightly between jurisdictions (the European Central Bank target inflation ‘in and around‘ 2%) is one that the world’s most prominent central banks continuously refer to in their communications.
To break it down, the position today is to continue to accommodate markets when inflation is running comfortably below target, and to withdraw support when inflation is close to or above the mandate.
Central bankers talk about the importance of their inflation mandate as though it is an economic holy grail, one that should be ever present in how they conduct policy. A cursory glance at recent history, however, shows this to be a fiction.
From December 2009 to November 2013, CPI (consumer price inflation) in the UK ran consistently above 2%. The high point came in 2011 when the inflation reading in September reached 5.1%. On average, though, this time frame saw inflation running between 3 and 4 percent. In response, the Bank of England kept rates at a record low of 0.5%, and even continued to create more artificial money via quantitative easing.
Quite clearly, the BOE had abandoned its inflation mandate. The Federal Reserve did the same thing in the United States. At several points in 2010 and 2011, CPI was running above 2%. Yet rates remained at record lows and quantitative easing continued.
The narrative at the time was that the global economic ‘recovery‘ following 2008 was still fragile, and therefore accommodative polices were justified. Inflation targeting was not a primary focus. It was an afterthought.
To expand on this, let’s look at the International Monetary and Financial Committee (IMFC) which is part of the International Monetary Fund. The committee is described as one that ‘advises and reports to the IMF Board of Governors on the supervision and management of the international monetary and financial system, including on responses to unfolding events that may disrupt the system‘. The UK, United States, Germany and France are all members of the committee.
In 2009, the IMFC ‘advised‘ that expansionary policy (low rates and quantitative easing) remained appropriate – advice that was acted upon by central banks over the ensuing years.
Three years later in 2012, at the committee’s 25th meeting, the IMFC stressed how monetary policy should remain accommodative ‘as long as inflation prospects remain anchored and weak growth persists.’ Central banks duly maintained accommodation.
It was in October 2013 that the language started to change. At the 28th meeting, the IMFC mentioned for the first time the prospect of an ‘eventual transition towards normalising policy‘, insisting that any transition be ‘well timed, carefully calibrated and clearly communicated.’
In the same October meeting, the committee referred to an improved global recovery, cautioning that growth was still ‘subdued‘ and ‘downside‘ risks remained. Central banks took no immediate action on monetary policy.
Two months later, however, the Federal Reserve changed course, and announced it was to commence with tapering it’s asset purchasing programme. This is where the ‘transition‘ the IMFC spoke of began.
The next key moment was at Davos in January 2014. Here, IMF managing director Christine Lagarde (who recently stepped down in preparation for becoming governor of the European Central Bank) announced the need for a global economic ‘reset‘, which included the ‘areas of monetary policies.’ I wrote an article on this subject in January 2019 (Monetary Policy ‘Reset’: From Rhetoric to Actuality) which offers more detail.
The next IMFC meeting in April 2014 saw the committee state that monetary policy ‘in advanced economies‘ (which includes the UK and U.S.) should persist in providing ‘the necessary accommodation‘. The move towards ‘eventual normalisation‘ was conditional on price stability and economic growth. They added that the Fed’s tapering of asset purchases ‘remains appropriate.’
Come October 2014, the Fed stopped purchasing treasury and mortgage backed securities, with their balance sheet having risen from under a trillion dollars in 2008 to $4.5 trillion.
A few weeks prior to the Fed’s actions, the IMFC met again to report similar findings. The recovery continued, but was weaker than anticipated with ‘downside risks arising from challenges associated with monetary normalisation, including protracted below target inflation.’
Inflation was now consistently below 2% in both the UK and the U.S.
Moving forward to 2015, the position of the IMFC (then chaired by the current general manager of the Bank for International Settlements Agustin Carstens) was of a continuing global recovery. At both the 32nd and 33rd meetings, the committee maintained that with inflation giving way to deflation, ‘accommodation should be maintained where appropriate, consistent with central bank mandates.’
It was in December 2015 that the Fed raised rates for the first time in nearly a decade. This was with CPI inflation below 1%, and core inflation (which excludes food and fuel costs) sitting at 2%.
Two months before the June 2016 EU referendum, the IMFC specifically cited the ‘shock of a potential Brexit‘ as posing ‘spillover risks‘. With inflation way below 2%, they recommended that accommodation should continue. Not just in line with central bank mandates, but now with an awareness of ‘financial stability risks.’
A few weeks after the leave vote, the Bank of England cut interest rates to 0.25% (with inflation at 0.6%) and restarted quantitative easing.
By October 2016, the IMFC raised ‘rising geopolitical uncertainty‘ as a risk going into 2017, and affirmed a commitment to ‘resist all forms of protectionism.’ As with previous meetings, the policy of low inflation requiring accommodation remained. But this was caveated with a warning that ‘monetary policy by itself cannot achieve sustainable and balanced growth, and hence must be accompanied by other supportive policies.’
After Donald Trump was confirmed as the next American president, the Federal Reserve raised rates in December 2016. In the same month the ECB announced they would begin purchasing less bonds through their asset purchasing programme.
In 2017 the committee detailed how the recovery was now ‘gaining momentum‘, with the risks of deflation receding. What little growth there was in the economy was according to the IMFC being tempered by ‘political and policy uncertainties.’ In regards to monetary policy, the same stance conveyed at earlier meetings was carried forward.
Inflation was now picking up. In the UK it was edging up to 3% following sustained devaluation of sterling since the referendum result. Come November 2017, the Bank of England raised interest rates to 0.5%, reversing the August 2016 cut.
Meanwhile, the Fed raised rates three times in 2017, and also announced they would begin rolling off assets from its balance sheet.
By the time the 37th meeting came around in 2018, the IMFC were now directly advising central banks to gradually withdraw monetary accommodation ‘where inflation looks set to return to targets.’
In August 2018, the Bank of England raised rates to 0.75%, with inflation still running above 2%. In the U.S. the Fed raised rates four times in 2018, taking them up to the 2.25-2.50% range. CPI inflation at the time was averaging 2.5%.
Later on in the year at the 38th meeting, in spite of ‘heightened trade tensions‘, ‘ongoing geopolitical concerns‘ and ‘risks skewed to the downside‘, the IMFC declared that accommodation should continue to be withdrawn in a ‘gradual, well communicated and data dependent manner.’
A couple of months on, the ECB ended its quantitative easing scheme, having purchased assets worth up to €2.5 trillion.
So far in 2019, the normalisation of monetary policy has, as the BIS described it, been in ‘a holding pattern.’ Neither the BOE, the Fed or the ECB have moved on rates so far. The Fed announced in March that they would end their balance sheet reduction scheme this coming September, meaning that at present they continue to roll off assets whilst keeping rates on hold.
The 39th meeting of the IMFC, held in April of this year, noted that whilst the economic ‘expansion‘ continued, the risks of trade tensions, policy uncertainties and geopolitical fallout remained. Having ‘advised‘ previously that accommodation should be withdrawn with inflation above target, this changed slightly to read that central banks ‘should ensure that inflation remains on track toward, or stabilises around targets.’ Decisions undertaken by banks should ‘remain well communicated and data dependent.’
The latest significant commentary from the international stage came in June with the BIS annual economic report. The editorial of the report outlined how central banks had put ‘the very gradual monetary policy tightening on pause.’ But they also gave what I would consider an explicit warning, in that ‘should inflation start to rise significantly at some point, it would induce central banks to tighten more.’
As with the IMFC, the BIS declared how ‘monetary policy cannot be the engine of higher sustainable economic growth.’ This harks back to the phrase ‘central banks cannot be the only game in town‘ that first gained traction several years ago.
Following on from the BIS, the IMF’s latest World Economic Outlook published in July called for monetary policy to ‘remain accommodative especially where inflation is softening below target.’
As invariably has proved the case, soundings on the international level feed their way down to the central banks themselves, and end up becoming part of their own communications and a prelude to adapting policy. This indicates to me that the power base in central banking does not lie with individual banks, but rather with the global institutions -namely the BIS and the IMF. Central banks in my view are appendages of the financial system. Their actions, particularly over the past few years, have been highly coordinated. This is evident by how closely the IMFC’s reports have mirrored the behaviour of central banks. The only difference has been in the speed in which banks have begun rolling back on accommodation.
Shortly after the BIS’ annual report, a speech by Bank of England governor Mark Carney expanded on the international analysis. In brief, Carney re-emphasised that the direction of monetary policy in the event of a no deal Brexit could go either way.
I would underscore the MPC’s caution that the response of monetary policy to Brexit will not be automatic. The MPC can stretch the horizon over which it returns inflation to target but it would never do so to the point of breaking.
UK monetary policy will remain guided by the constancy of the inflation target.
Thanks to the actions of the BOE over the past three years, we now have a reference point in which to measure the weight of Carney’s words. By allowing inflation to reach 3% before raising rates in November 2017, this was the bank ‘stretching the horizon over which it returns inflation to target.’ In other words 3% was the most they would tolerate. How much they would tolerate in the wake of a no deal Brexit is another matter entirely.
By stating that policy will ‘remain guided‘ by the 2% inflation target, this chimes with what Federal Reserve chairman Jerome Powell has been saying. Recently Powell has stated that the Fed ‘will act as appropriate to sustain the expansion, with a strong labor market and inflation near our symmetric 2% objective.’
This implies that inflation can fluctuate either side of 2% for a period before the central bank will take action. Exactly when tolerances would have be breached has not been specified by the Fed.
Keep in mind that central banks are pushing heavily the importance of their inflation mandates in the face of rising protectionism and nationalism / populism. Prior to this new dynamic in the political sphere, the clear intention was to maintain accommodation and all but ignore what are supposed to be mandated targets. During what has become perpetual geopolitical unrest, inflation suddenly matters again.
Incidentally, the geopolitical unrest in question – the UK’s separation from the EU and trade tariffs imposed by the Trump administration for instance – are inflationary by nature given the affect on the value of currencies and the price of goods.
In a previous article (Markets are being Lulled into a False Sense of Accommodation), I remarked on how both mainstream and alternative commentators have failed to ask why it is that amidst Brexit uncertainty, trade protectionism and low growth, central banks remain resolute behind their inflation mandates, whereas in the years after 2008 they did not.
I would contend that this is because resurgent protectionism and populism are not a barrier to central banks. They present an opportunity for inducing a financial downturn through the instrument of monetary policy. As I have remarked before, without the onset of crisis, globalists have no other means of pushing for greater control over the financial system.
What we have seen from the BOE and the Fed is a policy of invoking the relevance of inflation targeting when the time suits.
In the speech by Mark Carney referred to above, he went on to say how a global trade war and a no deal Brexit are the two leading economic concerns, and the cause of uncertainty for businesses, households and markets. How might monetary policy respond?
In some jurisdictions, the impact may warrant a near term policy response as insurance to maintain the expansion.
Could this be taken as an indication that the Federal Reserve may diverge on monetary policy in the near term and cut rates? Although I consider it more likely that they will leave rates unchanged for now, it cannot be discounted entirely.
If communications emanating from globalists continue to include inflation as a primary concern when conducting monetary policy, it would suggest that should a significant rise in inflation occur – off the back of geopolitical events – central banks will act to tighten policy in the name of ‘financial stability.’
Whilst it is conceivable that in the near term some central banks may loosen policy (as we saw with the Bank of England after the referendum), I would caution against the notion that this would indicate the beginning of a rate cut cycle.
Ultimately, inflation targeting is not just a monetary tool. It is a weapon. As a confluence of global events conspire to come together, I fear that the mandates which only a short time ago held no relevance to central banks are going to be weaponised. And if that happens, it is highly unlikely that the public will hold these institutions to account.
Instead, I believe the vitriol will be aimed squarely at figureheads within the political system, and not at the globalists who have presided over the biggest economic bubble (falsely sold as a recovery) in history.