Monetary Policy: From Tool to Help States Make Structural Reforms to Excuse Not to Carry Them Out

February 16, 2021 Updated: February 23, 2021


The constant financing of deficits in countries that perpetuate structural imbalances has not only not helped to strengthen growth, since the eurozone and the United States already suffered downgrades of estimates before the COVID-19 crisis, but is also driving inflation higher.

Monetary policy has been ultra-expansive for more than 10 years, in crisis, recovery, growth, and stabilization. In fact, the central bank becomes hostage to states that don’t reduce their structural imbalances but perpetuate them because the cost of debt is low and the central bank “supports” them.

It’s no coincidence that the reformist momentum has stopped short since 2009. It coincides exactly with the period of never-ending balance sheet expansion.

Low rates and high liquidity have never been an incentive to reduce imbalances, but rather a clear incentive to increase debt.

Once in place, the so-called expansionary monetary policy can’t be stopped. Does any central banker believe that states with a structural deficit greater than 4 percent per year are going to eliminate it while there are negative rates and liquidity injections?

The worst excuse of all is that “there’s no inflation.”

It’s not by chance that the eurozone saw massive protests against the increase in the cost of living while we read that “there’s no inflation.” But it’s also, at the very least, imprudent to say that there’s no inflation without considering the increase in non-replicable goods and services (rent, fresh food, health care, education, etc.) and financial assets that have rocketed with this policy.

Negative yields in 10-year sovereign bonds of insolvent economies are part of huge inflation. Rising prices for non-replicable goods and services, which in many cases are triple the official inflation rate, as a 2020 study by Bloomberg Economics shows, is especially worrying when monetary policy encourages unproductive spending and perpetuates overcapacity. This means lower real wages in the future due to lower productivity growth. Bjorn van Roye and Tom Orlik at Bloomberg Economics conclude: Not only is real inflation higher than the official consumer price index (CPI), but it’s also much higher for the poorest citizens.

A recent study by Alberto Cavallo of the Harvard Business School and Bloomberg Economics warns of precisely this differential between real inflation suffered by consumers, especially the poorest, and the official CPI.

Now it’s not just a matter of detailed study. Inflation expectations have risen to a five-year high, and the inflation figure in Germany and the United States in January is particularly concerning for two reasons: It’s rising faster than central banks and governments estimated, and it’s only kept low by an energy component that will likely soar in the following months after oil recovered 22 percent in the first two months of 2021 and most commodities are up between 3 and 7 percent in the same period, according to Bloomberg.

In fact, if we analyze the cost of living with the goods and services that we really use frequently, we realize that in an unprecedented crisis such as that of 2020, prices for the poorest layers rise almost triple what the CPI shows, and that, added to the distorting factor of the enormous inflation in financial assets, this generates enormous social differentials. This wealth destruction is even more evident in the first month of 2021.

The German wholesale price index rose 2.1 percent in January versus 0.6 percent in the prior month. This is the highest in 10 years. Details are even more concerning: meat (+3.5 percent), fruit (+3.2 percent) and vegetable (+3.1 percent) prices are rising at a level not seen in a decade, and this is considering that these prices didn’t fall in a significant way in 2020 either. Net rents are up 1.3 percent, services of social facilities 6.0 percent, and maintenance and repair of vehicles 3.4 percent.

Now, remember that the German wholesale price index was kept low by a fall of more than 3 percent in the energy component. However, no German citizen has seen a fall of 3 percent after taxes and surcharges in their energy bills.

In the United States, the situation is similar. Inflation expectations are at a seven-year high. However, according to Deutsche Bank, the prices of education, health care, and housing are rising faster than real wages and official CPI. In fact, according to Deutsche Bank’s Torsten Slok, since 2000, these prices have risen between 2 and 2.5 times faster than the official CPI. According to Shadowstats, “In general terms, methodological shifts in government reporting have depressed reported inflation, moving the concept of the CPI away from being a measure of the cost of living needed to maintain a constant standard of living.”

Many analysts state that this rise in inflation will be temporary due to the base effect of the re-opening of most developed economies and the fast recovery in commodity prices. This is absolutely correct, and we will likely see a slowdown in official inflation in the second half of 2021. However, this isn’t likely to be the case with the goods and services we really buy, and the rise in non-replicable and essential goods and services will remain significantly above real wages and the official CPI.

This pricing pressure creates even more inequality, as it affects mostly the poor, and becomes a real burden for most middle-class families, which have seen wages fall but the prices of goods and services that they can’t eliminate, or substitute, rise even in crisis times. Furthermore, the poor and lower-middle-class don’t benefit from the asset price inflation created by monetary policy.

Former Federal Reserve Chair Ben Bernanke used to say that central banks are not in charge of fiscal policy and that this is a matter of fiscal policy. Well, it’s not. Massive money supply growth and its negative consequences aren’t solved by raising taxes and increasing subsidies. This just perpetuates the problem and creates a zombie subclass that can never recover from the boom-and-bust periods.

What’s the biggest risk? It’s that even if inflation overshoots, central banks can’t stop the easing machine because insolvent governments would go into a massive debt crisis with just a few percentage points yield increase. Faced with the choice of helping consumers or governments, most central banks will choose the latter.

Central banks can’t ignore the effect of fiat currency debasement in this cost-of-living problem because it will get worse and can lead to significant social unrest and discontent. It can all be mitigated with a simple Taylor-rule-based policy that eliminates discretionary and random policy changes.

If you want to protect your savings, gold and silver are important assets to own, especially physical assets, not just financial instruments. Equities only help while monetary policy continues to create asset inflation, but that can stop abruptly when money supply growth coincides with nominal GDP growth, as the multiple expansion effect dies. Sovereign bonds aren’t a solution as both the price and the yield make them the most expensive asset.

As such, gold, silver, cryptocurrencies, and inflation-linked bonds may be ways to protect wealth against fiat currency debasement.

Daniel Lacalle, Ph.D., is chief economist at hedge fund Tressis and author of “Freedom or Equality,” “Escape from the Central Bank Trap,” and “Life in the Financial Markets.”

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.