‘Actual Damage’

There was a “clear change of heart” among G10 central bankers late last month, TD’s James Rossiter said, while documenting an epochal policy pivot which, for better or worse, will be enshrined in tomorrow’s economics textbooks.

Like all simultaneous shifts in developed market monetary policy, the events of the past six weeks are the subject of conspiratorial narratives. But, as Rossiter wrote, no such speculation is necessary.

“The conspiracy theorists would go so far as to say the hawkish pivot was a coordinated shift in policy, and while there may be some truth to that, the less exciting explanation is probably that they all look at similar data using similar models,” he said.

Unfortunately, the data shows headline inflation “just keeps going and going and going,” and while core is softer, TD cautioned on second-round effects tied to pass-through from “extreme” moves in energy prices.

The figure on the left (below) is simple, but poignant. If you traveled back in time to 2019 and showed that chart to policymakers in advanced economies, they’d surely convene an emergency meeting to discuss what measures could be taken to preempt it. Considered through that lens, it seems especially peculiar that the very same policymakers watched it unfold right in front of them and only acted on a lag.

The figure on the right (above) is even more disconcerting. In both the US and the UK, almost two thirds of basket items are rising by 5% or more. Canada isn’t far behind.

A TD indicator that pools more than 100 inflation expectations measures across the G10 shows very little in the way or relief or moderation. Generally speaking, they’re rising every month.

That’s a serious problem. I’ve been over this and over it, but it feels like it never resonates: At a time when citizens in many Western democracies have lost faith in traditional institutions as a result of bad policy and populist propaganda designed to capitalize on voter disaffection, central banks absolutely can’t afford for longer run inflation expectations to become unmoored.

It’s not just that citizens have lost faith in public officials. That happens all the time. The problem is that voters in advanced economies are increasingly predisposed to doubting the validity of the system itself. Social media, by design, amplifies the most bombastic rhetoric, thereby making it feel as though everything is unraveling in real time. That, in turn, creates a sense of entropy.

When you introduce rapidly rising prices for food, gas and other necessities into that equation, you have a recipe for unanchored expectations and a loss of confidence in monetary policy, especially considering the extent to which central banks are lightning rods for precisely the kind of conspiratorial thinking that poisoned the public discourse.

I should note that spiraling inflation in advanced economies wouldn’t be “hyperinflation,” per se. Not in the textbook sense of the term. A cup of coffee won’t be $40. But what if a single Snickers bar was $4 in the Walmart checkout line? What if a jar of regular peanut butter was $12 at the grocery store? What then? Nothing good, that’s for sure.

Consumers have an innate sense of what things “should” cost when purchased under normal circumstances, where “normal” means not at an airport, or a sporting event, or a concert venue, or a move theater, or in a city known for high prices. There’s a tolerance band, but it’s pretty narrow. If you’re not at a movie theater, you’re probably not going to pay $5 for a regular-sized Snickers bar, for example. That’s way outside the tolerance band. Everyone has such a tolerance band for almost everything they might ever want to buy. Typically, we’re not cognizant of those bands precisely because they’re rarely breached, and when they are, it’s not because of inflation, it’s because we’re being opportunistically gouged at a concession stand, something we understand and accept. What we won’t understand (or accept) are concession stand prices at grocery stores.

As discussed here at length in “Inflation Blame Game: Whose Fault Is This Really?” there’s no chance of politicians rising to this occasion (or any other occasion for that matter). They may send out relief checks, but that’s a suboptimal solution except as it applies to the lowest-income households. Relief checks are a palliative, not a cure.

In these circumstances, central banks have no choice. For the better part of a year, policymakers waited and hoped for evidence that the situation would “fix itself,” as it were. But, as TD’s Rossiter wrote, “central banks who had hoped that weaker real income growth would ‘do the job’ for them now realize that this won’t be enough.”

And, so, we’re left with one very sobering conclusion. As Rossiter put it, “central banks therefore need to inflict actual damage on economies to reduce inflation, whether via much weaker growth or a higher unemployment rate.”

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4 thoughts on “‘Actual Damage’

  1. “..it seems especially peculiar that the very same policymakers watched it unfold right in front of them and only acted on a lag.“ – if you have a massive debt and inflating it away is one way of dealing with it, is it really surprising that central banks act with a lag when dealing with it?

    1. Treasurys, gilts, JGBs, etc. aren’t “debt.” They’re interest bearing dollars, pounds and yen. This is another positively maddening aspect of popular discourse around markets and economics. Nobody on any side of any debate tells the whole truth. The US doesn’t have “a massive debt.” It has a bunch of interest-bearing dollars outstanding and paying interest on them will never be a constraint because the US government can issue as many dollars as it pleases. This a continuum where DMs are on one end, EMs in the middle and corporates/private citizens on the other. You (not you personally, but “you” as in private citizens) have “a massive debt” because you can’t print money. The US government has no “debt.” It has an obligation to pay out interest in dollars on dollars. But is that “debt”? Can you “owe” a sum denominated in a currency you issue? Not really. You don’t need to “inflate it away” or at least not where that means letting exogenous factors drive consumer prices through the roof. Someone will argue with me here and I won’t respond because it’s not a debate. It’s a fact.

      1. It’s hard to argue against that. When people borrow money and have to pay it back with interest that’s debt. Same for businesses. So it’s not hard to get to the notion that it’s the same for governments. It doesn’t help when everyone on the media also calls it debt. Maybe part of that is the lack of a widely understood term that defines that well – “interesting bearing dollars’ doesn’t have the same ring to it 🙂 or maybe most people aren’t interested in thinking about it much…

  2. You are correct, especially for the amounts held by the Federal Reserve. What would really be cool is to have the Fed transfer most of the debt on their books to the social security and medicare trust funds- so instead of book entries those balances would be fully funded and the debate about cutting benefits or folks worrying about the fund going bust would be over. The most laughable misuse of the facts would be when Standard & Poors cut the debt rating of the USA- they had the wrong metrics and the cause of the deficits was the meltdown of the financial system that S&P had a hand in causing. And when they cut the ratings rates dropped and bond prices for US debt rallied.

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