Brace for QE all over again, and let us get it right next time

There has been no fundamental reset of the monetary process. The International Monetary Fund says that for all the noise we remain in the grip of ‘secular stagnation’.

The inflation spike caused by the pandemic and Putin’s war – or rather, caused by a miscalibrated burst of central bank money in response to those shocks – is essentially a one-off adjustment in the price level.

The same powerful forces that have bedevilled Europe and America since the Lehman crisis will reassert themselves, this time spreading to China and large parts of the developing world. 

Let us call it the slow ‘Japanisation’ of the planet.

“Monetary institutions may have to resort to the same strategies they employed in the decade before the pandemic… Even the central banks in some emerging market economies may eventually need to adopt unconventional policy tools,” the IMF said.  

The world is still getting older. Much of Asia is following Europe into a demographic death spiral. The growth rate of productivity has collapsed in the West and is collapsing in the East.

The global capital glut lives on; meaning that excess savings dwarf the opportunities for profitable investment. 

Labour arbitrage and technology have allowed owners of capital to take too much of the pie, and they have a low propensity to spend. 

They accumulate yet more instead. The workers are taking too little. Inequality remains at post-war extremes. The whole structure is out of kilter.

Over the last forty years these forces have pushed down the Wicksellian ‘natural rate of interest’ – the neutral Goldilocks level – by two percentage points in the West. 

It is now doing the same to the others. This is why we cannot shake off deflation so easily.

Such at least is the IMF’s hypothesis. 

You can dispute every premise. If you think that globalisation is fast unravelling (I don’t) the argument collapses. 

It sits oddly with escalating green deals on each side of the Atlantic. 

The argument skips over the ‘China effect’ since the 1980s: the global flood of cheap Asian goods enabled by suppressed currencies. The IMF has to censor itself.

But it is just as plausible as the inflacionista story that Covid has suddenly propelled us onto an entirely different pathway. Furthermore, it has profound implications for how Britain should set policy for the 2020s.  

This debate in the IMF’s World Economic Outlook may seem surreal at a time when the cost-of-living shock still captures the headlines. 

But inflation is a lagging indicator and a crude compass for policy. Rate-setters would be less prone to boom-bust cycles if they targeted nominal GDP instead. 

It would have told them that policy was far too restrictive in early 2008, and far too loose in early 2001.

If the tidal pull of global forces is going to tame inflation anyway, one might ask why the Fed, the ECB, and the Bank of England keep raising rates. 

They risk detonating a systemic crisis in the shadow banking nexus for no worthwhile reason. The gamble is even harder to justify if, as the IMF implies, the danger lurking on the other side of the hill is our old nemesis: Fisherian debt-deflation.

This has been the most aggressive rate cycle of modern times. 

It has been turbo-charged by something that central banks have never done before and struggle to explain in their models.

They have lurched almost overnight from QE to reverse-QE (QT), a $2 trillion global switch in annualised liquidity flows. Such tightening hits with a lag. Best estimates are that we have so far felt just a third of the impact.