The credibility of the central bank

For a central banker, credibility in financial markets is essential for an effective policy. The moment inflation deviates too far from the target, there is a risk of loss of confidence. 

For a long time, Jerome Powell maintained that he was not even thinking of raising interest rates before 2023. Now the Federal Reserve is about to raise interest rates as much as three or four times this year. The US central bank’s target is an average inflation rate of 2 percent. After the Great Financial Crisis, inflation remained below that average for a long time. Despite the recent rise in inflation, we are still a long way from that long-term trend of 2 percent. According to official policy, it is therefore still too early to raise interest rates. Powell also indicated that the Phillips Curve is no longer the basis for US monetary policy, but now the Fed is carefully studying the labour market in search of a signal that wages are rising. Apparently, the Fed suddenly fears a wage-price spiral. Both the Fed and the ECB have maintained, almost against their better judgment, that the current inflation is temporary. A few months later, they admit that they were wrong. 

This year, this very history is causing unrest. There is panic. The buy-back programme needs to be wound down twice as fast and ideally, the Fed would start raising interest rates today. In the FOMC, the policy-making body of the system of American central banks, there is even talk of quantitative tightening. This means that the Fed’s balance sheet will shrink by no longer reinvesting the proceeds of bonds that are released. Moreover, Powell also seems to have no idea where it will end. According to the FOMC, the ultimate target for the policy rate is 2.5 percent. That is not a central bank applying the brakes, that is still a central bank that sees higher inflation as a temporary phenomenon. The market has no choice but to follow. The 10-year interest rate in the United States is still at the same level as in April last year. The biggest buyer in the bond market is still the central bank. Furthermore, there are many institutions that are forced by laws and regulations to buy bonds, regardless of the price. The bond market is manipulated, the current interest rate is no longer the price of money. 

Consumer confidence is falling. Not because of an impending recession, but because of high inflation. If Powell wants to stimulate the economy, he must fight inflation. That sounds very neo-liberal, whereas they had just started a new chapter of Keynes. For financial markets, it is suddenly very annoying that central banks have been given an even greater role in the system. The pursuit of financial stability, fighting the debt crisis, and also financing the energy transition no longer go hand in hand with fighting inflation. With fiduciary money, trust is a great asset; thanks to the monetary madness of recent years, they are now in danger of losing that trust. That is when the currency is the ideal outlet.