Central banks are still worried about the danger of deflation, even though they have timidly started to lift interest rates. How else would they explain real negative rates almost everywhere in the developed economies?
The Bank of England raised interest rates for the first time in 10 years by a quarter of a percentage point to 0.5% last week, but consumer price inflation is at 3%; so in fact Britain has a real negative interest rate of 2.5%.
And that is without taking into consideration asset price inflation, which for some strange reason central banks keep ignoring.
Equity valuations are at sky high levels in the US, whereas in the UK, where houses are the investment of choice, house prices have increased so much that first-time buyers who don’t have access to the bank of mum and dad have given up getting on the proverbial “housing ladder.”
You know that central banks’ game is up when jokes like this begin to circulate online:
It's a theory. pic.twitter.com/6IpN3XWmZS
— Patrick Chovanec (@prchovanec) November 4, 2017
Still, investors celebrate the negative-for-longer (or even forever) policy on real interest rates.
Stocks markets hit fresh highs. Global equities now worth $92.4tn, equals to 120% of global GDP, way above the Buffett 100% crash threshold! pic.twitter.com/Fn48X8s9gA
— Holger Zschaepitz (@Schuldensuehner) November 4, 2017
We’ve seen this film before, and we know it doesn’t end well. The problem, of course, is that we don’t know when it ends.
The more serious issue is that policymakers do not know themselves what they want. If stoking inflation was such a big priority, then fiscal authorities in the major economies around the world could have slashed tax on income, or even introduced a temporary “negative” tax on income.
This could have worked like this: a fiscal stimulus could have been awarded to the lowest-income households in work. People like cleaners, waiters, agricultural workers, etc. would have received, say, a 20% boost from the Treasury on their salary, and would have paid no income tax at all.
Most of them would have gone out and spent that, rather than saving it, because low-income households usually have a lot of pent-up demand: they may need a new washing machine, a new fridge, a new car.
They would not have spent it only on goods. Services would have benefited too, as they perhaps could have afforded some “luxuries” like having their hair professionally coloured at the hairdressers, rather than doing it in the bathroom themselves. Or, if still doing it in the bathroom, paying a proper decorator to repaint the walls after having dropped the bottle and splashed hair dye all over the place.
All that spending power would have been sure to push up consumer demand and consumer price inflation. The state could have perhaps raised value-added tax incrementally to try to recoup some of the revenue lost, or it could have improved tax collection from big multinational companies.
None of this was even discussed, let alone enacted. Instead, the central banks cut interest rates to record lows and bought huge amounts of assets to kick-start inflation, with dubious results. In the meanwhile, as this article on Positive Money argues, the Bank of England widened inequality to levels impossible to reverse.
The richest 20% of households in Britain each gained, on average, £314,413 in net wealth due to the central bank’s ultra-low interest rates policies. For the poorest 20%, the increase in wealth was £1,659. Put differently, quantitative easing and low rates have helped the rich 190 times more than the poor. You have to wonder what the policymakers were thinking.