Giants of central banking will be cut down to size

December 30, 2015

The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

Central bankers were the next best thing to superheroes during the financial and euro zone crises. But after rescuing banks, markets and even countries, they have finally encountered their kryptonite: consumer prices.

Inflation has refused to materialise despite the most unorthodox efforts of the most influential rate-setters. U.S. Federal Reserve Chair Janet Yellen, European Central Bank President Mario Draghi and others in the Group of Seven industrial nations have slashed policy rates to record lows and together bought financial assets worth more than $10 trillion – roughly equivalent to the combined currency reserves of all the world’s central banks.

Central bank balance sheets

Economic activity has picked up but consumer prices are proving recalcitrant. G7 inflation averaged less than 0.2 percent in the first 10 months of the year, OECD data shows.

G7 inflation

Worse still, central bankers’ power to bend markets to their will is waning, reducing their ability to weaken currencies and thus make imports more expensive. Draghi’s old nickname of Super Mario looked less apt after his Dec. 3 policy easing had the perverse effect of pushing the euro and bond yields up sharply rather than down.

Time to deploy other policy levers. First, governments could start gently reversing half a decade of fiscal policy tightening. The mostly rich OECD countries will in 2015 run a structural deficit – that is, one which strips out the effect of economic swings – of 2.5 percent of potential GDP, the lowest in a decade and a half, the international organisation says. Voters’ austerity fatigue and circumstances such as Europe’s migrant crisis and security concerns all suggest some slippage ahead.

Second, pay could do with rising faster. In 2014, real average wages in the OECD rose 0.2 percent, less than a fifth of the average annual increase seen between 2000-2007. Politicians are already thinking along these lines. Japanese Prime Minister Shinzo Abe plans to raise the national minimum wage by 3 percent each year from the next fiscal year, and the UK wage floor is due to rise more rapidly in the coming years.

Even fiscal and wage measures might fail. Further falls in oil prices or a Chinese currency depreciation could counteract their inflationary impact. But that shouldn’t stop politicians from using what powers they have – especially now central bankers are proving helpless.

One comment

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The middle class has been bankrupted and can no longer consume at the levels that will drive inflation. Prices go up and we consume less, then the market goes down. The geniuses in the financial industry are too brainwashed to see this. Everyone I know is cutting back because they have to. Real dollar wages are extremely low and people are finding ways to be thrifty. It may be a good thing to get out of the consumption race. People are not made happy by possessions.

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