ALL MAJOR CENTRAL BANKS HAVE AN INFLATION TARGET, WHICH IN MOST CASES IS 2.0% YR/YR, BUT OVER THE PAST 10 YEARS, ONLY THE FED AND BANK OF CANADA HAVE ACHIEVED THAT TARGET IN BROAD TERMS, MEANING THAT INFLATION HAS FLUCTUATED IN A RELATIVELY NARROW RANGE.


Perhaps this is the wrong prism through which to view these developments in any case. But it does seem sensible to adopt a sceptical questioning stance, as per the Helsinki syndrome, on central banks’ ‘superior’ knowledge and understanding, given that this is effectively assumed in their forward guidance to keep policy rates and other measures at current levels at least until 2023. Before looking at some of the questions that may need to be raised about what any post pandemic economic recovery might look like, there are some questions about central bank key policy variables and their policy toolboxes, as well as post-GFC regulation and markets which would to be appear unavoidable.


All major central banks have an inflation target, which in most cases is 2.0% yr/yr, but over the past 10 years, only the Fed and Bank of Canada have achieved that target in broad terms, meaning that inflation has fluctuated in a relatively narrow range. By contrast UK CPI has been far more volatile, though far from out of control, while Eurozone and Japanese CPI have persistently undershot target, often by a large margin. In Japan’s case, the BoJ has had interest rates at or close to zero for more than 20 years, and has been deploying some variation of quantitative easing for nearly two decades. To be sure, one can argue that argue that are structural factors at work in Japan, but the fact remains the BoJ has via its various quantitative easing programmes acted as a backstop buyer of many domestic asset classes for a very long time, and has in fact never ever put a plan in place to reduce the size of its balance sheet, now more than 100% of Japan’s GDP. Indeed, outside of the Fed for a brief period in 2018/19, no major central bank has ever tried to reduce the size of its balance sheet, thus giving the lie to the originally rationale of QE. Let us recall that the idea that was central banks reduced rates to near zero, purchased high-quality, low-risk assets from banks, who in turn could lend more to businesses and consumers, and restore confidence in the economy, and once the economy was on a sustainable growth and inflation path, and financial conditions were stable, central banks would reduce the size of their balance sheets and ‘normalize’ rates. But this never actually happened, in no small part because it relied on ‘trickle down’ economics, and instead of QE flowing into the economy, it was funnelled into financial markets, inflating asset prices and inequality, allowing governments to sit back and do nothing to address what were and are much needed structural reforms. It can be argued that the sharpening of bank capital requirements in the wake of the GFC clearly hampered the hoped for ‘trickle down’ effects, but that is only part of the story.


Firstly it was always going to be the case as current BoE chief economist observed in 2014 that: “One of the likely consequences of the crisis, and the resulting regulatory response, is that the financial system will reinvent itself. Financial activity will migrate outside the banking system. And with that move, risk may itself change shape and form. What previously had been credit and maturity mismatch risk on the balance sheet of the banking system may metastasize into market and illiquidity risk on the balance sheets of non-banks.”


7 | ADMISI - The Ghost In The Machine | Q1 Edition 2021


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