It was either a calculated gamble or a display of utter certainty on Wednesday, when the Financial Times released a lengthy story describing a “crisis of confidence” among central bankers. The worry, according to the FT, centers on their ability to manage inflation and unemployment using the traditional tools of monetary policy. Indeed, it asks whether those tools have ever really operated in the way they were thought to in the first place.
The story came out on the same day that minutes from the September meeting of the Federal Open Market Committee were released, creating at least the possibility that the official record of the discussion among the Federal Reserve Board members and the Federal Reserve Bank presidents might douse the theory in cold water by displaying a level of confidence and certainty about the direction of inflation in the US.
It did not.
The result of the meeting was a unanimous vote to keep interest rates stable for the time being, but the minutes reveal concern bordering on confusion about the current state of inflation. All the indicators that would normally point to rising inflation are in place - and have been for an extended period of time. Unemployment is low, economic growth is rising, interest rates remain near historic lows. But inflation stubbornly refuses to move toward the Fed’s two percent target rate.
“Many participants expressed concern that the low inflation readings this year might reflect not only transitory factors but also the influence of developments that could prove more persistent,” the minutes read.
“Some participants discussed the possibility that secular trends, such as the influence of technological innovations on competition and business pricing, also might have been muting inflationary pressures and could be intensifying,” the document added. “It was noted that other advanced economies were also experiencing low inflation, which might suggest that common global factors could be contributing to persistence of below-target inflation in the United States and abroad.”
It was at that point that things apparently got a little bit meta, and members began discussing the impact current inflation rates might have on future inflation numbers, largely by influencing the public’s expectations about what “normal” inflation really is.
“Several [FOMC members] expressed concern that the persistence of low rates of inflation might imply that the underlying trend was running below 2 percent, risking a decline in inflation expectations. If so, the appropriate policy path should take into account the need to bolster inflation expectations in order to ensure that inflation returned to 2 percent and to prevent erosion in the credibility of the Committee's objective.”
Overall, the September minutes reinforce a point made before: The Fed doesn’t appear to know what’s going on with regard to the interplay between monetary policy, inflation, and unemployment.
In Wednesday’s FT article, Chris Giles made a powerful argument that the problem isn’t limited to Washington, but is global, extending to the Bank of England, the European Central Bank, and beyond.
To their credit, central bankers are becoming more honest about it, admitting that the economic models they have been using to try to steer the economy for a generation may not really reflect reality. “[T]here is increasing concern, even expressed by [Fed Chair Janet] Yellen, that the underlying theoretical model might simply be rotten to the core and attempts to tweak it are futile,” Giles writes.
He adds this damning observation from Daniel Tarullo, who served on the Fed board for eight years ending in April: “Essentially you are setting policy on things you don’t know and can’t measure and then reasoning after the fact.”
Tarullo’s “core argument,” Giles adds, “is that central banks maintain an absolute faith in the model with absolutely no evidence to support it.”
To be fair to central bankers, the article also demonstrates that their faith has been badly shaken. The problem now is figuring out what they really should believe.