Joachim Fels just isn’t giving in, part four.
Despite mounting signs of global deflation fear — as yields on ultra-long bonds fall — Morgan Stanley’s central-bank watcher and his colleague Arnaud Marès are still on inflation watch.
Simply because, well, that’s where central banks like to be, too. As they noted on Thursday:
Forced to choose between two evils. With extreme outcomes plausible rather than merely possible, central banks’ reactions are likely to be shaped by their relative degree of aversion to inflation or deflation. In other words, which outcome do they most want to avoid? We believe there are good reasons for all major central banks to fear deflation more than inflation.
The devil you know. First comes the weight of experience. There have been many successful (albeit at times painful) victories over inflation in past decades. There are only two significant episodes of sustained deflation in the past century: the United States in the 1930s and Japan post-1990. Neither inspires a great deal of confidence that the means to emerge from deflation are well understood – and effective.
It’s something we’ve heard before, in term of central banking psychology — there’s more than a bit of status quo bias and cost asymmetry here.
Central banks wouldn’t want to tinker with ways to get around the zero bound if a truly deflationary environment sets in, then — not least because the crisis has left them more, ah, interdependent with fiscal policy:
Aggregating, as one should do, the balance sheet of the government and the central bank, one can see that quantitative easing results in the substitution, on the ‘whole of government’ balance sheet, of long bonds for bank reserves. This has two effects: shortening of the maturity of government debt (by three years in the UK) and an increase of the sensitivity of the government’s cost of funding to policy rates. Assuming central banks were equally averse to missing their target to the upside or downside, they should prefer the outcome that is more favourable to government finances: that means inflation.
Err on the side of inflation and stay lower for longer. Music to Merv’s ears, that.
Related links:
The loss of central bank credibility, the coming inflation – FT Alphaville
XXL liquidity and a side of inflation, says MOST – FT Alphaville
If a central banker screams in a forest… - FT Alphaville, 2009