Central banks are indicating clearly that inflation may be the devil in their theology, but it's still the lesser evil.
By PINCHAS LANDAUinflation 88(photo credit: )
The Bank of England cut interest rates Thursday and the Bank of Canada cut its rate earlier this week. Next week, the Federal Reserve Bank is universally expected to cut the rate in America - for the third time in succession. Some people think that the Fed will cut by half a percentage point, as it did in September, but the greater probability is that it will make do with a quarter (as in October).
Granted, not everyone is in a cutting mood. The European Central Bank, which also met Thursday, chose not to cut - as expected - in its case. The Reserve Bank of New Zealand, a much less weighty player on the global arena, also held the line at its meeting this week. The Scandinavian central banks are also considered unlikely to cut their rates any time soon.
But before jumping to the conclusion that the world is divided into cutters and holders, it is worth remembering that only a few months ago the global trend was exactly opposite: most central banks were raising rates or thinking about doing so, and holding was seen as the alternative to hiking, not cutting. Indeed, the Bank of England raised its rate as recently as July - but that was before the financial markets went into a tailspin and central banks were forced to face the unpleasant fact that keeping inflation down was not the sole reason for their existence, although that's what they prefer to believe.
The degree to which the anti-inflation ethos is dominant in central bank thinking today shows through in every statement, press release or speech issued by these august institutions and their governors, committee members, etc. The starting-point of the debate is always - whether explicitly or implicitly - what the rate of inflation is now, is expected to be and ought to be according to the guideline of the specific central bank in question. The Bank of England, for instance, has a 2% per annum inflation target "over the medium term." But the annual rate of inflation in October was 2.1%. In normal times, therefore, the Bank would have either raised rates now to push inflation down next year, or explained why it was not doing so (for example, because current inflation reflects some transient factor and will decline of its own volition before long).
These, however, are not normal times. They are the most abnormal times anyone alive and functioning in any central bank - or any financial institution of any sort, for that matter - has ever seen. These are times in which commercial banks are reluctant to lend even to each other, let alone to ordinary customers who want to buy a house or car, or to corporations who want to acquire other companies. The result is a liquidity crunch in the financial markets and a credit crunch in the real economy. Most people, mercifully for them, don't know the difference between these two concepts, or their respective impacts on economic activity. Central bankers understand both ideas all too well, and can visualize their implications very clearly. That's why they haven't been sleeping well these last 15-20 weeks - but worry not as to their ability to focus on the matters at hand. As Dr Johnson noted, hanging concentrates a man's mind wonderfully, and all the central bankers' heads are in the noose now.
That is why the Bank of England on Thursday said, in effect, "yes, we know about inflation. It's higher than we would like it to be. What's worse, it's going higher. We see what's happening to energy prices and, even worse, to food prices. According to the accepted precepts of central banking, we should raise rates or at least make threatening noises. But you can fuggedaboudit. With an impending recession we have to cut rates, not raise them, because the economy is so reliant on debt that if we don't cut the price of money, we could move from recession to depression before you could say 'Bank of England.' In the best case, the recession will cut demand enough to bring inflation down, but will not be so severe as to cause a collapse in demand."
That's where all central banks stand today. Those who were going to raise are holding and those who were holding are now cutting. Those who cut in the past and are cutting now will end up cutting more, because the best case outcome is, as usual, unlikely. In any event, faced with what is for them the worst of all worlds - a choice between letting inflation move higher and letting the economy sink and banks possibly collapsing - central banks are indicating clearly that inflation may be the devil in their theology, but it's still the lesser evil.
landaup@netvision.net.il
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