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The Fed actually thinks it can drive 315 million
souls through a 0.2% gap in its forecasts...
REMEMBER INFLATION?
Central bankers do – and they want to get rid of it, writes Adrian Ash.
Not in the way they used to get rid of it. Back then they would raise
interest rates to curb debt-fuelled spending. Whereas now they want to throw
inflation out of their policy targets instead.
The true aim being to welcome it back to the real economy.
America's zero interest rates, said the US Federal Reserve on Wednesday,
"will be appropriate at least as long as the unemployment rate remains
above 6.5%." Coming just a day after 2013's new Bank of England governor
Mark Carney said he wants to swap inflation for GDP targeting, this marks a
new stage in a big and global shift.
Yes, inflation does get a look-in. The Fed swore Wednesday that it will keep
rates at zero only so long as inflation "is projected to be no more than
a half percentage point above the Committee's 2% longer-run goal" over
the next one to two years. But that projection is of course the Fed's to
make. And its 2.0% inflation target is already being fudged.
Half-a-point here, half-a-point there, who cares? Other than consumers,
businesses, savers and everyone else.
Also note – the Fed didn't say that hitting its new jobless rate will
definitely trigger a rate rise. And that 6.5% level for US unemployment is itself an ambitious goal.
Since 1948, US unemployment has averaged 5.8%. It stood at 7.7% in November,
and it has stood at or below 6.5% in only 550 of the last 780 months.
In short, strong returns to cash savers remain a very long way off yet.
Higher inflation will meantime be tolerated – welcomed, even – as
part of cutting Western governments' huge debt burdens. Real rates of
interest, after inflation, are likely to get worse below zero. Not least
because, while failing to raise interest rates, central banks will continue
to print money to buy government bonds – thereby pushing down the
interest rate they offer to other investors (ie,
you and the entire retirement savings industry).
"If Ben Bernanke thinks 4% is an appropriate level for inflation in the
US," says Jim Leaviss, blogging at UK fund
giant M&G, "you wouldn’t be lending money to the government at
0.65% for the next 5 years would you?
"And with Mark Carney taking over at the Bank of England next year,
market inflation expectations [you would imagine] would be overshooting the
2% inflation target over the next few years too?"
Put another way, "It's fairly clear, although not explicitly
stated," says the Fed chairman's sometime colleague and chum, Paul Krugman,
"that the goal of this pronouncement is to boost the economy right now
through expectations of higher inflation and stronger employment than one
might otherwise have expected."
So why would anyone hold fixed-income government debt? Abandoning all pretence (at last) of targeting low inflation, central
banks clearly want to see higher inflation. Because in the Fed's plan –
if not in reality, history or anyone else's model since the late 1970s
– the idea is that this will boost employment. So looking ahead to
2015, the US Fed's previous dateline for any fear of a rate hike,
"Financial institutions that want to report nominal earnings, let alone
avoid real losses on portfolios that will then include $15.5 trillion of US
obligations that pay essentially zero, will be desperately reaching for yield
and risk," writes Berkeley professor Brad DeLong.
"And whatever risky assets they buy to get some yield into their
portfolios will trigger somebody to then spend more on currently-produced
goods and services.
"[So] that possible future world," says DeLong, "is not a
future world in which unemployment is still above 6.5% and forecast core
inflation is still below 2.5% per year." And yet the US Fed itself, also issuing new forecasts
after Wednesday's new policy announcement, says precisely that. All the new
policy aim has achieved, together with a fresh $45 billion of quantitative easing
each and every month from hereon, is to tweak the forecast 2015 range for US
joblessness from September's guess of 6.0-6.8% to this month's guess of
6.0-6.6%. Core US price inflation is actually forecast to fall, hitting a
2015 range of 1.8-2.0%.
Is DeLong saying Ben Bernanke is lying? Or did he fail to check the Fed's new
predictions? Maybe the Fed is being disingenuous, ignoring the impact of its
policies on inflation so it can gain the political support needed to allow
them. Or maybe, just maybe, the fact is that the Fed – like all other
central banks today – is worse than clueless.
Frantically yanking its levers and smashing its dials, it actually imagines
it can direct the economy, now this way, now that, and drive 315 million
souls through a 0.2% gap in its forecasts. Yet instead, it risks driving the
currency over a cliff.
"At the surface level," Brad DeLong explained long ago, in a 1996
paper, the awful inflation of the 1970s happened because
no one who could "placed a high enough priority on stopping
inflation." Worse still, "no one had a mandate to do what was
necessary." Beating unemployment with cheap money was thus the only tool
in the box. So by God they would use it, even if it worked about as well as
beating an egg with a shovel.
Viewed from the zenith of central-bank independence in the mid-1990s,
"It is hard to see how the Federal Reserve could have acquired a mandate
[to tackle inflation by raising rates sharply] without an unpleasant lesson
like the inflation of the 1970s," concluded DeLong in that paper.
You might think that keeping inflation low is what central banks are for. But
that's so late-20th century! And the Fed this week walked further away from
that mandate. Central banks everywhere are similarly losing their
"independence" to keep inflation in check. So guess what comes next
– what must come next – before there's any true chance of central
banks hiking their rates to try and curb your cost of living.
Adrian Ash
Please
Note: This article is
to inform your thinking, not lead it. Only you can decide the best place for
your money, and any decision you make will put your money at risk.
Information or data included here may have already been overtaken by events
– and must be verified elsewhere – should you choose to act on
it.
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