If there’s one thing we’ve all learned in the past two years, it is that central bankers mean business – both literally and figuratively. In other words, when central bankers say they ‘have our backs’ in both extending the business cycle by promoting fuller employment and doing so without causing meaningful inflation, we should take them at their word. As such, central bankers “mean business” literally (meaning they will promote business interests) and figuratively (meaning they are serious, determined and dedicated to their mission). Then again, for the past two years, those two objectives have been mostly aligned. What if new circumstances were to make them mutually exclusive?
Looking south of the border, we had a modest yield curve inversion in the spring of 2019 and within a few weeks, then President Trump applied some considerable political pressure (something arms-length central bankers are supposed to be immune to) in order to get the federal reserve to cut rates, which they did in three successive meetings that autumn. At the time, inflation was benign and tellingly, unemployment was at its lowest level in a generation. In other words, by any reasonable standard, the fed had done a superb job to that point and no interventions or adjustments seemed necessary. Despite this, there were changes and a purportedly imminent recession was averted. Or not. After all, there’s no reliable way of knowing what might have happened had rates not been lowered that autumn.
These days, the narrative coming from central banks is that the recent spate of above-average inflation is ‘transitory’, meaning it will likely normalize around more traditional levels once the artificially low data of the post COVID year (basically Q2 and Q3 of 2020) falls out of the data set. Of course, no one knows for sure if the inflation we’re seeing now is genuinely transitory or the harbinger of a more prolonged period of elevated prices. There’s a Chinese proverb that states, “to be uncertain is to be uncomfortable, but to be certain is ridiculous.” I’m not for a moment suggesting that inflation is or is not transitory. Rather, I am respectfully skeptical of the central bank line.
It may indeed be true that the inflation fear will dissipate into nothingness before the end of the year. Then again, Deputy Prime Minister and Minister of Finance Chrystia Freeland has boasted that the fiscal support offered to Canadians over the past 15 months can act as a sort of ‘pre-loaded stimulus’ that will keep the economy humming long after the government cheques stop coming. What if Freeland is understating the impact? Specifically, what if Canadians are so euphoric about the economy re-opening that they start buying things and experiences like never before? Wouldn’t that kind of spike in purchasing activity risk a spike (or at least prolongation) in inflation?
There are some who think central banks are managing expectations about inflation being higher for longer to buy time and provide cover for an anticipated period of deliberate bank inactivity. In essence, what if central banks don’t act to control high and prolonged inflation because doing so (i.e., raising rates significantly and sooner than expected) would destroy both the economic recovery and the bull markets so many are currently enjoying?
One such commentator is Peter Schiff. In a recent tweet, he speculated that: “Not only won’t the Fed win an inflation fight, it won’t even step in the ring.” No one can prove anything and I am certainly not privy to the nuanced motives of monetary policy decision-makers. Much of macroeconomic management stems from instilling and maintaining a sense of confidence. My sense is that, at a minimum, central banks are talking a good game about standing at the ready and being prepared to act if inflation rears its head. The words are reassuring. The deeds are yet to be seen. If the reassurance is strong enough and plausible enough, the deeds might never be required. If, however, for some reason, inflation becomes heightened and prolonged, I wonder if central banks will act as swiftly and forcefully to raise rates to avoid an inflationary crisis as they did to lower them to avoid a recession in 2019 and a public health crisis in 2020. Central bankers may need to pick their poison some day early next year.