Why central bankers don’t understand inflation?

Frances Coppola in this piece argues that central bankers are trying to fight the demon of low inflation, which ironically they themselves have created:

Central banks have advanced all sorts of explanations for the failure of the inflation demon to awaken. Post-crisis fiscal austerity, which is a considerable drag on both growth and inflation. Globalisation, which forces workers in developed countries to compete with workers in countries where the price of labour is lower. Technological advances that threaten to replace workers with machines. The trend towards longer working lives as the population ages: recent research by the Bank for International Settlements finds that a higher proportion of older people in the workforce puts downwards pressure on wages. The rise of the gig economy, self-employment, casual, temporary and zero-hour contracts, alongside weakening union power, falling union membership and systematic dismantling of collective bargaining.

These explanations all boil down to the same thing. Labour power is much weaker than it was in the 1970s, and is still weakening due to a combination of government policies and global economic forces. Wage rises and inflation are on the floor and are expected to stay there.

Belatedly, central banks are beginning to wake up to their weakness. They have little power to raise inflation when governments are hell-bent on feeding the economic forces that are keeping it down. And although they say they would like to see wages rising, they are simultaneously signalling that if wages rise, they will stamp on them. Why bother raising wages, only to take them away again in higher interest rates?

The Federal Reserve’s Daniel Tarullo has warned that central banks are relying too much on “inflation expectations”. He advises that central banks should wait until inflation starts to rise before raising interest rates. Belatedly, they are now beginning to follow his advice. But in the fight against lowflation, central banks are largely irrelevant. Unless governments actively embark on initiatives to raise incomes and living standards, inflation will remain on the floor whatever central banks do.


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