Central Banks Fueling Inflation Rather Than Curbing It, Experts Say
At its current levels, inflation is a serious economic, social, and political problem – a scourge that disproportionately affects the poor and the financially inept. So, what is the Federal Reserve, the European Central Bank (ECB), and the Bank of England (BOE) doing to actively fuel it? Willem H. Buiter and Anne C. Sibert wrote for Project Syndicate.
Photo Insert: The US Federal Reserve
When it comes to meeting their price-stability mandates, major central banks have lost the plot. In April, 12-month US consumer price index (CPI) inflation was 8.3 percent, down from 8.5 percent in March, and the core personal consumption expenditures price index (which excludes food and energy) was 4.9 percent, down from 5.2 percent in March, according to the US Federal Reserve.
But, as Buiter, an adjunct professor at Columbia University, former member of the Bank of England's monetary policy committee, and former chief economist at Citigroup, pointed out, the Fed should be doing the opposite of what it is doing.
After raising the federal funds rate target range by 50 basis points to 0.75-1 percent at its May meeting, the Federal Open Market Committee (FOMC) indicated that it will maintain the 50-bps hikes in June and July.
According to the minutes of the May meeting, all participants agreed that the US economy was extremely strong, the labor market was extremely tight, and inflation was well above target. Nonetheless, they decided that the FOMC “should expeditiously move the stance of monetary policy toward a neutral posture.”
There are two issues here. To begin, the Fed's monetary policy should be restrictive rather than neutral. Instead, the FOMC simply stated that “a restrictive stance of policy may well become appropriate depending on the evolving economic outlook and the risks to the outlook."
Second, two additional 50-bps hikes are not necessary. The policy rate's upper bound will remain at 2%, well below the consensus estimate of a neutral rate of 2.5%. (The sum of a neutral real rate of 0.5 percent and the 2 percent inflation target.)
Balance-sheet tightening by the Fed was likewise limited. Starting in June, its holdings will shrink by $47.5 billion per month for three months ($30 billion in Treasuries and $17.5 billion in agency debt and mortgage-backed securities), followed by an open-ended series of monthly $95 billion reductions ($60 billion in Treasuries and $35 billion in agency debt and mortgage-backed securities).
However, it's worth noting that by the end of March 2021, the Fed's balance sheet had swelled to about $9 trillion.
Returning the balance sheet to where it was in early March 2020 (about $4.2 trillion) will take more than four years at the current rate of decrease.
And, according to Anne C. Sibert, professor of economics at Birkbeck University of London and a former member of the Central Bank of Iceland's Monetary Policy Committee, it will take more than seven years to reach the level of early September 2008 ($900 billion), before the Fed erected its Great Wall of Liquidity around financial markets.