Is it time to pull back stimulus?
That’s the title of a National Bank report, written by senior economist Krishen Rangasamy, that considers whether central banks should end loose monetary policy.
Rangasamy notes that quantitative easing hasn’t had the desired effect on inflation, with the annual core inflation rate averaging 1.6% in Canada and the U.S. and less than 1% in Japan and the Eurozone.
“The failure to hit their inflation targets did not engender humility among central bankers, the latter instead attributing the miss on inflation to temporary factors,” he says.
The report makes the case that central banks do a poor job of measuring inflation. For example, central banks forecast the output gap — and hence inflation — using inadequate macroeconomic models that ignore structural changes like technology and automation.
(Fun fact: China ramped up spending on automation over the last few years, culminating in the purchase of a record 90,000 robots in 2016 — more than 30% of global robot shipments that year. “This ability to control costs through automation explains why, to the Fed’s chagrin, prices for goods imported from China by the U.S. continue to fall on a year-on-year basis,” says Rangasamy.)
Further, inflation is perhaps low because of — not despite — ultra-loose monetary policy, suggests the report. That’s because pushing too much liquidity not only fuels asset price bubbles but also allows governments to shirk their responsibilities.
“That explains the lack of fiscal stimulus and a diminished sense of urgency in tackling reforms, which are arguably restraining growth and hence inflation in advanced economies,” says Rangasamy. “In Europe, for example, less than 3% of the recommendations put forward by the European Commission last year — such as reforms to tackle labour market rigidities and boost competitiveness — were implemented by targeted governments.”
With persistently low inflation and some asset prices arguably in bubble territory, Rangasamy suggests three potential ways forward:
- lower the inflation target rate to reflect structural changes from technology, making it easier to warrant rate hikes;
- keep the 2% inflation target but apply it to a new CPI measure that better captures assets like homes and securities; or
- acknowledge the problem of achieving inflation objectives and seek a second-best solution of preventing asset price bubbles.
Says the report: “But, given how invested central banks are in the current thinking on monetary policy, we seriously doubt there will be any mea culpas.”
For instance, the BoC, concerned about asset price bubbles, could follow the Fed’s lead by starting to remove monetary stimulus despite inexistent pressures on consumer price inflation, while continuing to express confidence that inflation will eventually return to target.
But, if his interpretation is correct, Rangasamy says a stimulus pullback is warranted, and the onus on generating growth and hence inflation should be placed on fiscal policy.
Read the full report.