The current discussion of monetary policy is in some respects reminiscent of that of the mid-2000s. Nowadays central bankers are fond of congratulating themselves for having staved off collapse through ultra-loose monetary policy. Back then it was common to hear the claim that the central bank focus on inflation had abolished the boom-bust cycle.
With the benefit of hindsight it is clear that things did not end well last time around. Boom and bust reasserted itself with the global financial crisis in 2008 and severe economic contraction. A decade later the world is still coming to terms with the consequences.
Of course, it does not follow that such complacency is being repeated. Certainly central bankers would claim that they have learned the lessons of the past. But, on closer inspection they are repeating some of their earlier mistakes.
Perhaps the most important is the emphasis on controlling inflation. For central bankers, this is always a top priority. For example, the Maastricht treaty, a founding document of the euro-zone, defines price stability as the primary objective of its central banking system. Other central banks, including the Bank of England and the Swedish Riksbank, pursue inflation targeting.
There are reasons why the focus on inflation has appeal. The emphasis on price stability emerged after the runaway inflation of the 1970s. Rapidly rising prices were difficult to live through as real incomes and asset prices rapidly eroded.
Focusing on inflation also enables central bankers to claim success as consumer prices are currently subdued. That is no doubt one of the things Mario Draghi, the European Central Bank (ECB) president, had in mind when he told the organisation’s June press conference that the euro-zone economy “continues to be strong”.
“Central bankers would claim that they have learned the lessons of the past. But… they are repeating some of their earlier mistakes”
The problem with such an approach is that it gives undue weight to inflation. Rising prices are unpleasant, but they are just a possible symptom of economic weakness rather than its cause.
More importantly the mainstream approach fails to recognise the centrality of growth in productivity – the amount produced by a person in a given time – to economic well-being. Humanity has benefited enormously from the incredible rises in economic output over the past two centuries.
Yet by this measure the euro-zone, and indeed the western world more generally, is performing poorly. Productivity growth has trended sharply downwards since the 1970s. Indeed Draghi himself has acknowledged Europe’s dismal record in this respect.
Pumping ever more money into a fundamentally weak economy, as the ECB is continuing to do despite its recent announcement, is likely to end badly.
Daniel Ben-Ami, Deputy Editor