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Don’t Be Fooled: The World’s Central Bankers Still Love Inflation

The Bank of Canada on Wednesday increased its policy interest rate (known as the overnight target rate) from 1.0 percent to 1.5 percent. This was the second fifty–basis point increase since April and is the third target rate increase since March of this year. Canada’s target rate had been flat at 0.25 percent for twenty-three months following the bank’s slashing of the target rate beginning in March 2020.

As in the United States and in Europe, price inflation rates in Canada are at multidecade highs, and political pressure on the central bank to be seen as “doing something about inflation” is mounting.

The bank is following much the same playbook as the Federal Reserve when it comes to allowing the target rate to inch upward in response to price inflation. The bank’s official position is that it could resort to very aggressive rate increases in the future in order to hit the 2 percent inflation target.

As in the US, it’s important for central bankers to sound hawkish, even if their actual policy moves are extremely tame.

The World’s Central Banks Are Still Committed to Monetary Inflation

In spite of their lack of any real action, however, Canada’s central bankers are comparatively hawkish when we look at the world’s major central banks. At a still very low target rate of 1.5 percent, Canada’s central bank has set a higher rate than the central banks in the US, the UK, the eurozone, and Japan. Indeed, in the case of the European Central Bank and the Bank of Japan, rising inflation has still not led to an increase in the target rate above zero.

Federal Reserve: 1.0 percentEuropean Central Bank: –0.5 percentBank of England: 1.0 percentBank of Japan: –0.1 percent

Moreover, the ECB and the BOJ haven’t budged on their subzero target rates in many years. Japan’s rate has been negative since 2016, and the EU’s has been negative since 2014.

The Bank of England recently increased its target rate to 1 percent, which is the highest rate for the BOE since 2009.

In the US, the Federal Reserve has increased the target rate to 1 percent, the highest rate since March 2020.

However, it’s clear that none of these central banks are prepared to depart from the policies of the past twelve years or so, during which ultralow interest rate policy and quantitative easing became perennial policy.

The Federal Reserve has talked tough on inflation but has so far only dared to hike the target rate to 1 percent while inflation is near a forty-year high.

The Bank of England apparently suffers from the same problem, as Andrew Sentence of the UK’s The Times pointed out this week:

There is a serious mismatch between inflation and the level of interest rates in Britain. The rate of consumer prices inflation measured by the CPI is now 9 per cent—four-and-a-half times the official target rate of 2 per cent. The Bank of England is forecasting that CPI inflation will reach double-digit levels by the end of the year…. The older measure—the Retail Prices Index (RPI), which is still widely used—is already showing a double-digit inflation rate (over 11 per cent). Yet the official Bank rate has been raised to just 1 per cent, up a mere 0.9 percentage points on the near-zero rate during the pandemic.

This mismatch is not confined to the UK. In the US, where inflation is currently 8.3 per cent, the official Fed Funds rate is also just 1 per cent. And in the eurozone, where inflation is 8.1 per cent, there has been no interest rate rise at all from the European Central Bank.

In other words, even with these tiny rate increases we’re seeing in the US and the UK, the Fed and the BOE aren’t as far behind the curve as the ECB, which in late May suggested it has started to consider reining in its easy-money policies. But in typical central bank speak, this means putting in place some small changes many months down the road. Specifically, ECB president Christine Lagarde stated that “based on the current outlook, we are likely to be in a position to exit negative interest rates by the end of the third quarter.”

Translation: “We might do something in five months.”

Anticipating the obvious response to this lack of action, Lagarde also insisted, “We are in a situation that is vastly different from the United States and we are actually perfectly on time and not behind the curve.”

Meanwhile, the Bank of Japan shows no signs of relenting on its dovish policy. In spite of the yen being in the midst of a historic slide compared to the dollar and the euro, BOJ governor Haruhiko Kuroda has made it clear he has no changes in the works.

A Strong Dollar by Default

This is all good for the dollar, and as we’ve seen in recent weeks, talk of a “strong dollar” has returned as other major central banks make their own fiat currencies look even worse than the dollar. The dollar, of course, is being rapidly devalued—but not as much as the yen or the euro.

Unfortunately, this gives the Fed in the US even more breathing room when it comes to getting away with inflationary monetary policy. Moreover, we have even started to hear complaints about this “strong dollar,” as we often hear from exporters, hack economists, and central bankers who think that a weak dollar helps the economy.

Perhaps the biggest danger here may be the adoption of an updated version of the late 1980s Plaza Accords designed to weaken the dollar. If the weak dollar advocates win that fight, we’ll be looking at a continued downward spiral in dollar purchasing power, all justified by the “problem” of a dollar that is too strong compared to other currencies. Weak dollar advocates are already working on it.

In the short term, however, the dollar is very unlikely to be the first domino to fall if the world is headed toward a sovereign debt or currency crisis. A crisis could actually trigger flight to the dollar and away from competing currencies. Ordinary people, however, will continue to face only bad options: continued high price inflation with only moderate wage increases—meaning declining real wages—or a recession that brings down inflation (both price inflation and monetary inflation) but drives up unemployment. Or there could be stagflation, with both a slowing economy and strong price inflation. None of the likely options are good news.

Key Rates

Federal Reserve: federal funds rate Bank of England: official bank rateReserve Bank of Australia: cash rateBank of Japan: overnight call rate (observed); (target rate)Bank of Canada: overnight target rateEuropean Central Bank: deposit facility ratePeople’s Bank of China: overnight rate