E Central Bankers Insist On “Looking A Gift Horse In The Mouth”

Another month brings another spate of data on job growth, wages and inflation which then feed into speculation of when the central banks will raise rates again. In July, the U.S. economy generated just over 200,000 new jobs and recorded an unemployment rate of 4.3%. Canada created 11,000 additional jobs and the unemployment rate fell slightly to 6.3%. On both sides of the border, analysts immediately started to lay their bets on the timing and extent of future rate hikes from their respective central banks. The game of how fast and far rates will rise now is afoot.

Yet what continuously gnaws at the back of the minds of bankers is that the real conditions that would justify rate increases are conspicuously absent. For nearly 18 months, we have witnessed economic growth in the 2% range, modest wage increases and inflation running well-below target. Inflation in the OECD countries is at the slowest pace in nearly eight years.Yet, the Fed seems bent on pushing forward with its plans to shrink its balance sheet, “very soon”, according to the latest FMOC minutes. The Bank of Canada just raised its overnight rate and now speculation is rife that we can expect another rate hike as early as October. The European Central Bank has sent somewhat mixed signals that QE will cease shortly but has introduced the notion that monetary tightening may be on the way.

 As the accompanying table demonstrates, the large economies have provided little in the way of support for such tightening measures. Inflation is running well below the 2% mark in June for most of the major industrialized nations. The one exception is the U.K. which has been hit by a major drop in the value of the pound in response to unsettled conditions regarding Brexit. 

Cardiff Garcia of the FT offers a very interesting interpretation why central banks seem to ignore the lack of inflation when he states that:

A central bank’s willingness to tighten policy despite meager inflation is sometimes considered optimistic because policymakers expect the economy to return to full employment and target inflation despite less support from policy…. Rather than greeting this development {i.e. low inflation} as a gift that allows them to keep bolstering their economies, central banks are cautious, as though they do not quite believe what is plainly manifest in the data.[1]

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Gary Anderson 2 months ago Contributor's comment

Perhaps the Fed wants to weed out weak companies and clip wages and not go too negative with rates while doing that next downturn.

Norman Mogil 2 months ago Author's comment

Gary. I did not think the Fed singles out sectors or specific companies in setting monetary policy. Why clip wages given the huge income inequality that is so much in the political arena? I think the Fed just cannot accept that negative real interest rates can exist in an economy that is growing. In graduate school we were all taught that the idea condition is to have non-inflationary growth and we have this and the Fed is does not like it. Go figure!

Gary Anderson 2 months ago Contributor's comment

Oh I agree. But I do think they have nefarious thoughts. I wrote this awhile back and don't know if you saw it: www.talkmarkets.com/.../stock-markets-fear-the-fed-more-than-war The chart and Yglesias make for a compelling case that the Fed does prune and does so to help capitalists over labor.

Norman Mogil 2 months ago Author's comment

I read the article and the data are correlated but does this mean it is causal? Does wage inflation lead to a recession? At any rate, the situation is different today where wages nominally are stagnant and declining in real terms. The Fed admits as much, so they must have some other motive in mind if they pursue higher rates.

Gary Anderson 2 months ago Contributor's comment

Well, prof, I knew that the Fed liquidated in the Great Depression and Great Recession. I know manufacturing jobs that declined from over 20 dollars per hour to under 15 in the Great Recession. What I didn't know is that smaller declines happened after the run up to every recession. There is a pattern here regarding Fed behavior, and I don't like it. I understand there are other reasons for pruning back, to slow bubbles in stocks, etc. But it is a nice benefit for the capitalist when wages decline too.

Norman Mogil 2 months ago Author's comment

I have no argument with your points about the decline in relative shares. It is the source of all the political woes in the US. How much is the Fed's doing is hard to measure. With real rates negative, there is room for real wages to grow. Yet, something is holding back real wage increases.