Central banks mustn’t forget the human cost of their war on inflation

Is it right for central banks to be waging all-out war on inflation when it’s hurting ordinary people who didn’t create the problem?
Widening interest rate-setting boards to include labour market economists and poverty specialists might produce fairer results for society

David Brown

Published: 10:00pm, 8 May 2023

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Recently, there was a shocking instance of how insensitive central bankers can be to the plight of ordinary folk facing extreme economic difficulties. With consumers still struggling to come to terms with the Covid-19 pandemic and the cost of living crisis, Bank of England chief economist Huw Pill made an unfortunate choice of words when he suggested Britons needed “to accept that they’re worse off” and stop bidding up wages and prices.

The Goldman Sachs alumnus’ words sounded out of touch with today’s harsh realities for many people. It begs the question of whether central bankers are doing a good job. Is central bank independence still fit for purpose or are reforms needed? Do our monetary mandarins, comprising former civil servants, academics and ex-investment bankers, live in too much of a cosseted bubble? Has inflation targeting lost relevance in a complex, multidimensional world?

It’s taken for granted that central bank independence is sacrosanct and that our monetary custodians are there to promote the right kind of conditions for sustainable, non-inflationary growth consistent with financial stability over the long term. This has generally meant keeping inflation under control at 2 per cent.

But recent history has seen some major failings, with global monetary policymakers falling short on a number of occasions. The central banks were asleep at the wheel leading into the 2008 global crash, then they left interest rates too low and for too long in its aftermath and now they are overreacting with drastic interest rates rises to try to catch up with high inflation.

The recent rapid run-up in interest rates has clearly taken its toll on global economic confidence, with recovery starting to struggle again. After its 10th consecutive rate hike in 14 months, even the US Federal Reserve is beginning to balk, with hints that a pause could be on the cards.

Fed chair Jerome Powell might think a recession in the United States is less likely this year, but with inflation heading lower, the central bank needs to get the economy back on track for sustainable recovery as soon as it can. The Fed may be keen to rebuild its anti-inflation credibility, but not at the cost of the economy slipping back into recession heading into the presidential election in 2024.

Is it right for central banks to be waging all-out war on inflation, which was mainly caused by a spike in global energy prices outside their control, and especially when it’s hurting people who didn’t create the problem in the first place? Risking recession to batten down inflation to 2 per cent seems wholly unfair to those less well-off who are suffering job losses, poverty, homelessness and hunger.

It’s the rise in the number of people resorting to food banks and sleeping rough that central bankers need to take into account. Using higher interest rates to reach 2 per cent inflation is a blunt and indiscriminate tool, especially when it’s the vulnerable in society who pay the price.

Japan is wrong – deflation was not the cause of its economic woes

There’s clearly a need for change and central banks should adapt to the times. The Fed’s remit to ensure sustainable, non-inflationary growth is not comprehensive enough and should go further to improve economic and social well-being on a much wider scale.

Achievable targets for growth, employment and inflation should be optimised while taking welfare considerations into account. If the Fed’s 2 per cent inflation goal can’t be met without damaging growth, employment and social fairness, then the target needs to change.

07:32

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The Reserve Bank of New Zealand takes a more progressive approach to monetary policy, targeting price stability but subject to maximum sustainable employment at the same time. The bank’s monetary policy aims to promote the prosperity and well-being of New Zealanders through a sustainable, productive and inclusive economy, boosting public welfare by reducing cyclical variations in economic activity and employment while keeping inflation between 1 and 3 per cent over the medium term.

It’s a template which could easily be adopted elsewhere. Fairer policymaking would definitely help improve economic confidence for all.

Central bank monetary policy committees need to think outside the box and come up with better solutions than simply hitting a bog-standard 2 per cent inflation goal. Widening rate-setting boards to include not just monetary experts but labour market economists, poverty specialists and behavioural scientists might produce fairer results for society in the long run.

Bearing this in mind, with inflation pressures easing right now, central banks need to go for growth and that means lower not higher interest rates ahead.

David Brown is the chief executive of New View Economics