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It was another one of those historical developments that meant far more than it otherwise had seemed. Not necessarily hidden agendas, more along the lines of the changing times; a visual or, in this case, legal changeover more profound than the seemingly blasé technical matters leading to this. The Bank of England in 1998 undertook a major shift, maybe its most consequential to date for a central bank whose origins stretch all the way back to 1694.

Central bankers like to speak on their own terms, employing a jargon-dense vocabulary at first meant to maintain the illusion of superiority if only to place a wedge between them and the public; or the public’s understanding of who they really are, what they do, and how they might do it whatever it ultimately is. Terms like “goal independent” or “instrument independent”, even “inflation nutter.”

The first of those refers to the manner in which a central bank is governed. Does it have the ability to set the goals from which it will conduct policy and by which it will be judged? In the “old” days, this was quite straightforward in the manner of Walter Bagehot and Knut Wicksell; maintain order in money typically by means of some widely-used interest rate.

But interest rate targeting had become problematic by the seventies’ Great Inflation, to put it mildly. In the wake of such disaster, central banks, even the Old Lady of Threadneedle Street, found itself in a new set of handcuffs – inflation targets.

By the early nineties, this became all the official rage worldwide with England among its earliest adopters. Except, in this instance the inflation target was mandated and also set by the Chancellor of the Exchequer. The Lady was not, and still is not, goal independent.

What the Bank of England Act of 1998 had accomplished was freeing the central bank in that other form of “independence.” It mandated the creation of a Monetary Policy Committee (MPC), something like the Federal Reserve’s FOMC. While the Chancellor would tell the MPC what level of inflation it must target, the MPC – Chaired by the Bank of England’s Governor – would decide in what manner and methods monetary policy would achieve that goal.

Instrument independence. Wait, isn't money the only instrument at a central bank?

The MPC consists of nine members, the Governor and four Deputies plus four external nominees put forward by the Chancellor.

Since the Bank of England was a central bank, one of the oldest, as previously noted, surely to get anywhere near the MPC candidates would have to be grizzled, highly experienced bank and money experts who cut their teeth down in the trenches of the modern institutional marketplace. Except, no; they are near exclusively Economists.

In fact, before the legislation ever came into force, the initial MPC’s external members were Willem Buiter of Cambridge (enough said), Charles Goodhart of the London School of Economics, Dr. DeAnne Julius who had been chief economist for British Airways, and Sir Alan Budd who was at the time working at the Treasury in his capacity as, you guessed it, head economist. They joined the five from the Bank of England, three of whom had been formally trained in Economics.

Such tradition in terms of instrument independence favoring this kind of professional cohort has been maintained in the twenty-three years since. Of the current eight members, Governor Andrew Bailey is actually the closest to not being one if only in that his formal training had been as a historian…then following it up by working at the London School of Economics before joining the BoE in 1985.

Why only Economists? Why 1998?

The final of our three jargonized phrases helps describe the rationale. It was Mervyn King, an Economist, who in 1995 warned about this growing official infatuation with inflation targets. Introducing two more terms, flexible versus strict, King noted that in the latter case, a strict inflation target, the central bank would risk a high degree of variance in output in order to achieve strict adherence to its numerical inflation mandate (whether either form of independent or not).

He said any central bank in favor of such doctrine would put itself in the class of “inflation nutter.”

Thus, the most efficient manner for any central bank to meet its inflation standard is to reject nutter-hood, pursue a flexible inflation target whereas many more economic variables and therefore underlying factors can be fused into the most coherent monetary policy “instruments” with the highest likelihood of sustained success. According to Economists.

Alan Greenspan himself had confessed in 1997 when appearing at Stanford:

“Increasingly since 1982 we have been setting the funds rate directly in response to a wide variety of factors and forecasts. We recognize that, in fixing the short-term rate, we lose much of the information on the balance of money supply and demand that changing market rates afford, but for the moment we see no alternative. In the current state of our knowledge, money demand has become too difficult to predict.”

What’s this about money demand? Quite simply, since the sixties central bankers noticed that the private banking system – increasingly globalized and tied together by hidden shadow money networks – was supplying non-traditional, non-measurable monetary forms (quaint things like repo and currency swaps). Officials had come to expect real economy participants to demand some level of traditional money, things like what’s in M1, in order to accomplish real economic transactions.

Instead, the banking system was supplying this unknown money in lieu of traditional forms, meaning, from the perspective of Economists and central bankers, there had been a growing demand shortfall. From the much more relevant point of view of the economy and banks, nothing of the sort; money was being supplied, even oversupplied in the seventies, by these other kinds.

And yet, all of policymakers and Economists (all the still rational ones) agree that inflation is everywhere and always a monetary phenomenon. Instrument independence combined with non-nutter targeting in reality means no money whatsoever; their real purpose is to attempt some manner of policy without understanding money at all.

Their instruments, instead, are the equivalent of varying colors of smoke combined with several different polishes upon related mirrors.

In lieu of any minimal monetary command, BoE’s MPC like the Fed’s FOMC therefore takes its inflation target and seeks out statistical correlations (what Economists really do rather than understand the intricacies and true nature of economies) from among a range of economic aggregates like GDP and especially the unemployment rate to sort of reverse engineer conclusions.

From an interest rate target full of tricks, the instrument of independence, their policy actually begins where it all ends if to reach an inflation target they know they can’t possibly know specifically and directly how it works. On the contrary, it is merely expected (via regressions forced out of only past experience) that the interest rate target will signal to consumers, employers, investors, and mostly bankers what they are meant to do.

Raise the interest rate target (the mere act of announcing this is, for these purposes, an “instrument” of monetary policy; I’m not kidding), banks take that signal and are actually figured to constrain their monetary and credit activities (more expensive, or something). In the opposite direction, reduce the interest rate target, and financials are supposed to behave more freely.

In raw monetary terms, which is where inflation comes from, this policy signal is then translated by the banking system into real and effective money details beyond the scope and capacities of central bank officials (they are, again, mostly Economists focused on math).

One of the requirements imposed on the MPC by the Bank of England Act of 1998 was that once the Chancellor of the Exchequer decides on the inflation target the Governor as Chairman must write a formal response to the Chancellor should actual inflation deviate by more than 1% from it in either direction. In this communique, whoever is Governor must specify what the MPC believes is the cause before then stating what will be done to rectify the situation.

You can probably guess what never gets mentioned.

The Bank of England’s MPC had to write one of these letters, more than a few, even during the last decade plus when inflation had hardly been the primary issue. You might recall in 2010 and the first half of 2011 how consumer prices (worldwide, not just in the UK) seemed incompatible with the hard luck global economy “somehow” still sputtering its way away from recovery.

The first of those, post-2008, was penned on May 17, 2010; with the British CPI to 3.7% annual, now-Governor Mervyn King wrote to tell Chancellor George Osborne not to bother much about this. In response, a letter dated May 18, Osborne thanked King for his confident reassurance.

“I am grateful for your explanation of the current elevated rate of inflation, at 3.7 per cent for April. A number of temporary factors have contributed to this elevated rate of inflation, including the VAT rate rise in January 2010 and high fuel prices. Clothing and footwear prices and duty increases for fuel, alcohol and tobacco have also contributed to the increase in inflation between March and April this year. The MPCs remit allows it to look through short-term movements in inflation and I note the Committee's view that the current elevated rate of inflation is expected to be temporary.”

This did, in fact, become the case; again, not just in Britain but worldwide as in 2011 “something” happened to put an immediate and declarative end on early “recovery” “inflation.”

That something was not, however, the factors the MPC’s (or FOMC’s) policymaking Economists had expected. In their view, inflation wasn’t going to be any trouble while macro “slack” was so widely indicated.

But some of them, a few, had noticed one critical lacking component that far in. In September 2010, with all sorts of financial (meaning: monetary) fireworks plaguing the global system throughout the year, the MPC’s Chief Economist, Spencer Dale, in a speech given at Cardiff first echoed King’s view that inflation would prove transitory before then raising this particularly thorny problem:

“The downside risks to the growth outlook, stemming in particular from the substantial fiscal consolidation now in train and the continuing constraints on the supply of bank lending, add materially to the downside risks to inflation.”

Dale was an Economist, so obviously he was going to crack on about “fiscal consolidation” otherwise known as austerity. But what was it he said about banks?

No inflation followed, therefore a three-year gap between the last of the first group written in early 2012 and those following by 2015. This time, however, these were required due to the fact the UK CPI kept deviating in the other direction – more than 1 percentage point below Treasury’s target.

Factors blamed were oil and the unfolding Brexit “uncertainty.”

By late 2017 and early 2018, however, more letters this time of the upward variety. A CPI in November 2017 at nearing 4% triggered one written February 2018 from then-Governor Mark Carney to then-Chancellor Philip Hammond. Nothing to worry about, Carney said, the MPC expected inflation pressures (rising oil, mainly) to subside and then build more slowly as full capacity (no slack or output gap) was reached.

“As unemployment has continued to fall, recently reaching its lowest level since 1975, pay growth has picked up. In the February Inflation Report, domestic cost pressures are expected to build further in coming quarters, as modest demand growth is sufficient to exceed diminished growth in potential supply. That means the small margin of remaining slack is absorbed and a small margin of excess demand emerges by early 2020 and builds thereafter. That supports a gradual rise in pay growth and building domestic inflationary pressures.”

So sure about the last part, the Economists taking cues from their models, the BoE had raised its benchmark “bank” rate for the first time in November 2017 and then again in August 2018. 

Despite the models and repeated assurances throughout 2018 as to slack, no more would follow, however.

In neither direction do these Economists adequately explain the longer run phenomenon which, over time, has found high rates of CPI only the exceptions rather than the more expected continued occurrence. Sure, commodity prices have a temporary effect, but why doesn’t the view of economic aggregates like the unemployment rate ever translate into any meaningful inflation?

Money demand? Money supply? Unknown at every time - except by way of indirect observation and rational, honest interpretation of what banks must be doing in certain markets. If they’re doing things to alter prices and market behavior, there’s your effective money. No need for Economics and Economics to bypass.

More letters will be forthcoming from BoE; one was already inscribed back in May. Nowadays, as 2010, these are and will be of the same kind as a decade ago – yes, CPI is up more than “allowed”, but transitory until slack is gone and only then the real inflation pressures.

No mention of money nor banks. Never.

Global bond markets actually agree with the MPC about global inflation potential including what might spill into the specific British section of the worldwide system; if only on the first part. Current consumer price changes are stout, but not likely at all to last.

But then – and this like back in 2010 is what matters most – nothing in the beyond. No pickup in pressures due to a tight labor market nor an economy nearing, equaling, or exceeding its potential is priced anywherein any government bond market. Nothing. Zip. Zilch. The banks, meaning the money, is double missing (I can make up terms, too!)

Inflation is a monetary phenomenon yet decades ago Economists rather than bankers took the reins of “monetary” policies. The system changed except no one outside was ever notified. Inside the (hollow) halls of “power”, they talk about independence and instruments, even something nutty about nutters, all of it pretend.

It's all theater. That is their chief instrument, the same which required that flexibility. And the Economists.

Jeffrey Snider is the Head of Global Research at Alhambra Partners. 

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