Pharmaceutical companies have patent portfolios, fleets of the great powers have aircraft carriers, and central banks have their “canonical” econometric models.
Polished and optimized over the decades, the canonical models (all quite similar to one another) prove, not least to the central bankers themselves, that their decisions are based on a coherent philosophy.
The profession does not want to appear driven by whims, a desire for current popularity, or micropolitical intrigues among the board members of the Central Bank. It is designed to encourage productive investment and equitable economic growth, not speculation.
Two decades ago there was a general belief that in the event of a financial crash or economic emergency, central banks would act apolitically and disinterestedly to keep the system working. In the post-bailout world, rising social inequalities, a scandal over the trafficking of top Federal Reserve officials, and the politicization of high-level appointments have weakened public consensus.
There’s a lot more cynicism now. There is also a deep suspicion that all post-crash bailouts and “unconventional measures” made the rich richer. Central banks have acquired many financial assets but are losing public confidence.
When harassed and challenged by politicians or journalists, central bankers withdraw to recite what the canonical models tell them. The stated aim of the models is to identify what short-term interest rates, asset purchase programs, or “guidance” through public statements are necessary for the economy to achieve the elusive “R-star” rate.
R-star is the real short-term interest rate that is compatible with full employment and a long-term stable inflation rate. Politically, this is the central banker’s nirvana.
Not that R-Star is meant to be solid or stable over long periods of time. The stable interest rate should rise when technology development or education levels improve fast enough to increase the potential growth rate of the economy. Or if productivity drops due to a plague or an aging population, the R star is lowered.
Central bankers’ job would be much easier if the R-Star could be easily observed at all times, such as on a page on a Bloomberg screen. These rates could simply be picked and entered into input fields for the canonical models. Presto: politics.
But no. R-star, the key rate, the guiding stone for central bank policy, is unobservable and can only be estimated by economists who make an educated guess as to what it should be when no direct empirical information is available.
The guesswork has gotten pretty depressing over the decades. R-Star has declined more than 5 percentage points in advanced economies since the 1980s. And since the 2008 financial crisis, R-Stars have converged to very low levels across the developed world, as if waiting for an economic recovery that will never occur.
Are central banks signaling to the private sector that little growth is possible and is this depressing and misleading belief reflected in central bankers themselves?
Yes, says Phurichai Rungcharoenkitkul, business economist at the Bank for International Settlements in Basel. In a paper co-authored with Fabian Winkler of the Federal Reserve Board, the two state that central banks and the private sector “misunderstand the macroeconomic impact of their own actions as real information. You stare into a hall of mirrors. “
Rungcharoenkitkul and Winkler tweak the standard policy model to prove that in recent years, “an aggressive political strategy can be less effective in reviving spending if the Hall of Mirrors effect is in place, and worse could be the problem posed by the policy makers are trying to make it worse ”. to solve”.
In other words, central banks have kept policy rates too low for too long by staring at reflections of their own recent policies, and their communication of expectations has depressed long-term private sector saving and investing.
Unproductive activities were inadvertently encouraged. The prolonged setting of low interest rates resulted in overpriced housing, poor class or labor mobility, and an increase in leveraged speculation.
We have asked the central banks to take too much responsibility for the economic recovery. And we mistakenly expected them to be omniscient, even when they rely on the private sector for essential pointers.
As a result, the “signals” and “messages” from central banks appear to have created confusion and undue long-term economic pessimism. And, as the BIS reports put it, “the more the private sector and the central bank overestimate each other’s economics, the more severe the consequences.”