There has been a lot of talk lately about what the mandate of a central bank should be. The Fed has a dual mandate of low inflation and full employment, while the Bank of Canada focuses on keeping inflation between 1% and 3%, 2% being the optimal rate. So how’s that working out?
The latest inflation figures for Canada greatly alarm me. This year we’ve reached lows unseen in the past few years, and though this has happened before, these figures just seem so much more ominous under the current economic conditions than they did in the ’90s. The latest fluctuation was caused by a drop in oil prices, but it’s the second month this year that inflation has dropped substantially below the 1% lower limit. It is becoming clear that low interest rates are becoming more ineffective the longer they are kept down. I am NOT implying that the solution is to raise them, rather I am wondering what good a mandate is if the central bank no longer has the tools to carry it out?
The deflationary saga is one familiar to Japan, which has been experiencing the frustrations borne in part by loose monetary policy rendered ineffective by overuse. The US is faring slightly better:
…but is following a trajectory similar to that of Canada. I presume that the Fed would prefer a slightly higher rate–1.1% is lower than it’s been in recent years and the QE continues, albeit amid rumours that it will be tapered off at the end of the summer.
And how is the Fed doing in its quest for full employment?
Not too bad, I suppose. Unemployment is sitting at 7.5%, which is certainly an improvement from the 10% seen in the aftermath of the recession. But it is still too high for the Fed to claim that it has effectively carried out its mandate. Loose monetary policy is supposed to lower unemployment and increase inflation, but it has done neither. The reasons for this are many, as discussed in my groundbreaking magnum opus on “Trekonomics,” but for my purposes right now the reasons aren’t important. What is important is that the Fed is less effective than ever before in carrying out its mandate. It’s not that it’s doing a bad job, it’s simply that the economy has adapted to loose monetary policy in much the same way that the Borg adapt to the frequency of phasers used against them. (Oh geez, the Borg could represent so much in economics. I’m saving this.)
As the chart clearly shows, unemployment rose after the recession caused by the bursting of the dot-com bubble, but declined steadily afterwards due in part to measures taken by the Fed. We can see a comparable decline in unemployment after the Great Recession, also partly due to the actions of the Fed. However, unemployment rose so sharply between 2008 and 2010 that, even though the Fed was able to adjust the unemployment rate by the same amount as it did in the years after the dot-com bubble burst, it has not been enough to get the rate down anywhere near what it was before the recession. So a central bank’s power is limited, which is unsurprising to everyone except, perhaps, Alan Greenspan, (former) Master of the Universe. The powers of central banks are feeling a little too limited lately, however, which in itself is not a problem if governments are prepared to pick up the slack. Unfortunately, what seems to be happening is that central banks are being charged with the tasks of creating economic activity and keeping unemployment down without being given the tools necessary to do so. The mandate is beginning to look like a way for governments to shirk responsibility for these things, while central bankers’ every move comes under unprecedented scrutiny.
A central banker can only react to events such as a housing crash or a drop in oil prices. It is the government’s job to ensure that the economic well-being of its country is not dependent on just one industry. It should accomplish this through regulation and diversification of industry. Oil is a volatile thing to be hinging our entire economy onto, and even if it weren’t, no country should be so dependent on any one resource that its inflation rate tracks price fluctuations of that resource, as Canada’s does.
So now my question is: what good is a mandate? While it’s admirable for people, androids, and institutions to aspire to be more than they are, the refusal to innovate justified by unrealistic expectations is inexcusable. It is realistic to expect that monetary easing will have a measurable effect on unemployment and inflation; it is not reasonable to expect that it will have a greater effect than ever before just because we need it to.