The only central bank mandate that really matters is unemployment (theirs)

The anticipated blaming of central banks has well and truly begun. But where will it lead? Somewhere very nasty, if you ask me.

In Sri Lanka, a mob of protestors targeted the central bank after inflation spiralled out of control.

In the United States, President Joe Biden has been trying to palm off responsibility for inflation to the Federal Reserve, while also claiming he’s trying to resolve it… with more spending!

The Federal Reserve promptly published a report which blame Biden’s spending for the inflation…

The European Central Bank has constructively apologised for being so wrong about inflation… but it still hasn’t raised interest rates!

In the UK, a spat between a prime ministerial hopeful and the Bank of England governor got downright weird. The Daily Mail had the best summary:

‘What’s triggering inflation is the lack of sound money,’ Mr Tugendhat said.

‘What we’ve got here at the moment is we haven’t been controlling our own money supply adequately.

I’m afraid the quantitative easing that has been pumping up the economy and inflating a sugar high of growth in different ways through the quantitative easing, what we’ve actually done is we’ve lowered the cost of money, effectively.

But the governor disagreed: “I’m afraid I don’t subscribe to the view that QE is responsible.”

What? Creating money through QE (a.k.a. quantitative easing, as explained below) doesn’t cause inflation? You’ve got to be joking!

I haven’t heard that since the Weimar Republic’s central banker’s Twitter feed got shut down. And his mock account was sarcastic. Even if the real Rudolf von Havenstein actually believed it…or claimed to…100 years ago. But I’m still not convinced the German intellectual class was that dumb.

The Bank of England Governor’s claim was so odd I decided to do some real research about it. Off to the Bank of England’s website I go…

Click on “QE at the Bank of England: a perspective on its functioning and effectiveness” which was published in May. Yes, of 2022. And I find, in the opening two sentences…

Quantitative Easing (QE) involves large-scale asset purchases by a central bank, financed by the creation of central bank reserves. These purchases seek to boost aggregate demand and hence inflation.

Do I need to add the emphasis?

It’s no wonder, as the Telegraph points out, that the chief economist of the “Bank of England admits misleading the markets”.

But that misleading wasn’t about QE, it was about interest rates. The subheader explains: “Chief economist describes the language used on interest rate rises as ‘a trap’”.

A trap?

Yes, a trap for you, dear reader.

They tried to goad you into borrowing more money while it was cheap by promising to keep interest rates low.

And then they hiked rates so fast it’s going to cause a recession, making the debt unaffordable in terms of both the interest bill and your recession shot earnings.

Adding insult to injury, they also argue you shouldn’t ask for a pay rise because that would make inflation even worse…

In Australia, the central bank is coming in for some epic criticism for laying the same trap. And that criticism including an open letter to the governor (of the Reserve Bank of Australia) which begins “Just a short note to say thanks for the bum steer” and “it just doesn’t pass the pub test”.

It was published in the newspaper of the nation’s capital city, Canberra. But the Reserve Bank of Australia is safely hosted in Sydney.

This tweet sums up Australians’ fury:

Don’t listen to anything [Reserve Bank of Australia Governor] Philip Lowe says about interest rates or how high rates might go. He hasn’t got a clue. Six months ago he was saying no rate rise before 2024. He really has no idea.

And if the guy who is setting the interest rates has no idea, he really shouldn’t be making any comments about interest rates in 2024.

To sum up, central banks admit they’ve misled you on interest rates, they were surprised by inflation after trying to cause it, they now claim their inflation generating tool of the past decade and a half doesn’t create inflation, and they still haven’t got inflation under control.

It’s a shambles.

So, what’s really going on here?

The answer is very simple.

Central banks only have one mandate. It isn’t inflation, nor unemployment or financial stability. It’s to further the careers of those people running them.

That’s it, nothing else actually matters in practice.

Why is this true? Because they’re humans, like the rest of us.

They’re just put in a truly bizarre position of having to come up with an interest rate for the entire economy – something which no good economist would claim to be able to do for any other price because we all know price controls don’t work. Except in energy bills, of course…

Central bankers have to balance inflation and unemployment, despite the two not being connected.

And they have to ignore the solvency of their employers – the politicians – while doing so. Because raising interest rates to fight inflation means adding to the government’s interest bill.

What does this mean for monetary policy?

It means that central bankers react to whatever is best for themselves as individuals, just as the rest of us do.

There are two considerations. Remaining in their role as central banker, and ensuring a cushy job after they quit.

This means keeping the political establishment happy (and fully funded). So, once inflation becomes a political concern, they suddenly spring into action. But not before.

That happened in the 1970s. And it’s happening again now in many parts of the world. But not all of them, as we’ll see.

In the United States, inflation is the top concern of those polled. And they’re googling “recession” almost as fast as “inflation”. In response, the central bank is busily tightening monetary policy.

In the UK, the central bank is using words like “apocalyptic”, to describe the situation. And the Bank of England is raising rates too.

But inflation is not the most important political concern everywhere. Some politicians have other priorities and some are not as electorally accountable as others. And so their central bankers have different priorities too.

In the euro area, for example, governments are more worried about going broke than they are worried about inflation. And so the European Central Bank (ECB), has dragged its feet about tightening monetary policy.

I’d suggest that ECB President Christine Lagarde doesn’t want to tarnish the reputation of her predecessor at the ECB, who is now running Italy.

Don’t forget, the ECB will cease to exist if the euro disappearss. That makes the institution a little biased when it comes to raising interest rates to fight inflation, if you ask me…

Over in Japan, inflation has finally arrived after decades of official policies to fight deflation. Inconveniently it arrived at a time that government debt is so high that the central bank can’t hike rates without risking an interest bill disaster.

Conveniently, the Bank of Japan’s Governor Haruhiko Kuroda is set to retire soon.

Once retired, Mr Kuroda will no doubt be picked up by the private sector. The Japanese call this the “descent into heaven”. This, I think, means that the Bank of Japan’s real mandate is even more powerful than usual. He won’t be doing anything until his descent from heaven is secured.

My point is that, if you presume that central bankers are ordinary people with ordinary aspirations and fears, then their policies and actions make lots of sense. That includes the denials, seemingly bizarre changes of course, and complete stuff-ups.

It’s only when you presume that central bankers are not people that you expect them to do what they’re supposed to according to things like “mandates”.

This is why so many economists have suggested rules-based central banking in the past. People are just too fallible in reality.

I wonder if it’s why Charlie Morris uses his Money Map to guide his investment decisions in an objectively structured sort of way. It’s a set of rules about how different asset classes behave in different sorts of environments. If you can identify where we are on the Money Map, you can know which way asset prices are going to go.

Find out where we are now, here.

Nick Hubble
Editor, Fortune & Freedom