This article is an on-site version of our Chris Giles on Central Banks newsletter. Sign up here to get the newsletter sent straight to your inbox every Tuesday
With US readers back at work after their Thanksgiving weekend, the indications suggest shoppers were out in force, boosting the already strong US economy. In other developments, I am recovering from being quoted in a House of Lords report saying that quite a lot of the text in the Bank of England’s remit was “simply flab” which required “a good editor”. More on that below. Email me: email@example.com
Stephen D King on inflation
Earlier this year, Stephen D King published an acclaimed book, We Need to Talk About Inflation, outlining lessons he thought we needed to learn from the surge in prices over recent years. Last week, the HSBC senior economic adviser gave the annual Wincott lecture in London.
In summary, he said inflation was not about to crawl obediently into a box marked “no need to open until 2060”. I caught up with him for lunch earlier this week.
The interview below has been edited for clarity and concision.
Chris Giles: Your book asked us to talk about inflation. Now most people say the devil has been slain. Why is that wrong?
Stephen King: Even now inflation is persistently overshooting targets. The majority of central banks have struggled to get inflation down to 2 per cent and the costs have been very visible in terms of much higher interest rates than anyone could have possibly imagined two or three years ago. Even in the US, which has been one of the most successful in reducing inflation, core inflation there is still higher than it was when Jay Powell talked about inflation being transitory. That was back in August 2021. So, I would say that central banks still have a fight on their hands.
Chris Giles: What’s causing the stickiness in inflation?
Stephen King: The first thing is very simple — a repeat of the 1970s — which is to say that there was a refusal to admit that inflation was not just being caused by external shocks.
Second, it’s also how you’re perceived to react to those external shocks as a policymaker. If you simply claim that the shocks will come today and be gone tomorrow and you’re quite relaxed about it, there’s a significant risk that inflation will gain a domestic foothold, which is then difficult to get rid of.
The Fed rejected the transitory language quite early on when, in late 2021, Jay Powell said essentially, “OK, we’re going to retire the word transitory”. And ever since then the Fed has given a pretty clear indication of the fight on its hands. But it strikes me that the Bank of England was still using what amounted to transitory language all the way through until the early months of 2023. And with UK wage growth running at almost 8 per cent a year with zero productivity growth, there’s no way that can be possibly consistent with an easy return to the inflation target.
Chris Giles: Why do central banks need to get inflation sustainably back to their previous 2 per cent targets?
Stephen King: The risk of slippage is quite high. Institutionally this raises the possibility that central banks either raise their own inflation targets or have them raised for them. By all means have a debate about raising inflation targets, but it’s probably best not to talk about it when inflation has been persistently above target for quite a long time. It just looks like you’re trying to accommodate something and then you begin to embed inflation into society.
The problem with inflation ultimately is that it’s a deeply unfair, undemocratic process. I think that over the past 30 years when inflation has been low, people have forgotten about that aspect of inflation. They think of it perhaps as a sort of technocratic difficulty that central banks are there to solve. But actually it’s a political and social evil that redistributes income in an entirely arbitrary fashion.
Chris Giles: We’ve seen some welcome supply shocks with rising labour participation in the US and lower natural gas prices in Europe. Does this mean that interest rates have now risen too far and will squeeze the economy too much?
Stephen King: Some of the inflationary headwinds were always going to reverse. I’m not going to complain about that. But I think that the broader story of what was known as the Great Moderation is something which has been in trouble for longer than just the energy price shocks during Covid and after the Russian invasion of Ukraine.
We had a deflationary tailwind for many decades associated with hyper globalisation, borders and barriers collapsing around the world leading to tremendous efficiency gains. For any given growth rate, you could have lower inflation than previously. It was all easy.
The deteriorating relationship between Beijing and Washington, Brexit, friendshoring, reshoring, the rise of nationalism and populism are all signs of a shift long term away from that deflationary tailwind towards an inflationary headwind. So, yes, we’ve had some very good news in certain specific areas over the course of the last year or so. But the idea that we’re going to return easily to conditions before the global financial crisis doesn’t hold water.
Chris Giles: Higher interest rates are now making governments’ budgets less sustainable. How do you think that’s going to play out?
Stephen King: At the moment it’s like, no one cares, but they will care soon because the extra money being paid out in interest will begin to look quite frightening. If the bond market begins to penalise you, you’re limited in terms of the options that are available to you.
Obviously, you can raise taxes, but that is tricky. You can cut government spending, but you’ve got tremendous upward pressure from ageing, from additional defence spending and from the green transition to be coming through in the years to come. So if you can’t do much in terms of your standard fiscal policy, you’re left with a variety of what we might describe as non-conventional approaches to fiscal stabilisation — default, regulatory change that allows governments to jump to the front of the credit queue or financial repression of one kind or another. All would be damaging in terms of long-term growth.
The final option is inflation. And the truth is that inflation has been the preferred course of action for governments over centuries and centuries, when ultimately the fiscal numbers just don’t add up. So, I think it’s fine to pretend that fiscal and monetary linkages don’t exist anymore, central banks are independent etc. But if you have these rapidly deteriorating fiscal positions, you’d have to think that inflation is an option that is back on the table.
Remits, accountability and challenge
On Monday the august House of Lords economics affairs committee published a review of the Bank of England, 26 years after the government announced it would become independent. It said the UK’s central bank, along with most others, had made “errors” in dealing with inflation, but when I spoke to the committee chair, Lord Bridges, he said that the report’s recommendations could be summarised in three words: “remits, accountability and challenge”.
Bridges reminded me I had given evidence to the committee. At the hearing, I riffed that the additional text added to the BoE’s remit since 1997 was mostly flab, needed a good editor and many of the secondary objectives added to the BoE’s duties were really functions of government rather than the central bank (helping first-time homebuyers, for example). Sir John Vickers, former BoE chief economist, said any remit should pass a “Crick and Watson test” with fewer than 900 words, the length of the academic paper explaining the structure of DNA.
Journalists are often all mouth and no trousers, so I feel I need to put my words into action. In this article on my LinkedIn page, I have slashed the Monetary Policy Committee remit from its current 1,449 words to 766 words, trying to retain all relevant points. I am only an adequate editor, but this took just 15 minutes.
One example is to cut this paragraph:
The inflation target is forward-looking to ensure inflation expectations are firmly anchored in the medium term. The government believes that low and stable medium-term inflation is an essential pre-requisite for economic prosperity.
To this. The second sentence adds nothing apart from redundant words to a remit, since it duplicates an earlier passage.
The inflation target is forward-looking to ensure inflation expectations are firmly anchored in the medium term.
I’d love to know whether I’ve cut something crucial. firstname.lastname@example.org
What I’ve been reading and watching
The Fed and the ECB released minutes of their most recent meetings, with both seeing it as an opportunity to persuade financial markets they really are not thinking about cutting interest rates. The BoE joined the party with an FT interview of Huw Pill, the chief economist.
The ECB has also warned that it can see the first signs of commercial bank stresses arising in rising loan losses in commercial banks. For now, though, they are making record profits.
In Argentina, the planned dollarisation (without dollars) looks troubled within a week.
Talking of remits, UK chancellor Jeremy Hunt appeared to have seen a draft of the House of Lords report and cut environmental objectives from the BoE’s financial policy committee remit. That was welcome, but provoked quite a lot of manufactured outrage.
I can’t resist a plug for my column highlighting research that finds no increase in US income inequality over 60 years. To the extent that the Auten Splinter paper is true (and it has just been accepted in a top academic journal), it upends everything we thought we knew.