The central banks' Catch-22

November 19, 2021

Inflation is exploding. The reason is the central banks doing what it takes to keep the economy going. Now they are damned if they do and damned if they don't. Year on year inflation in the United States is 6.2%, 4.5% in Germany and only 3.8% here in the United Kingdom.

The central banks have two choices.

  1. Keep interest rates superlow (or keeping them well below inflation) and even continue to do quantitative easing;

  2. Or, raise interest rates to match, and even exceed the inflation.

So far, they have opted for the first.

If the inflation is transitory, and set to return to below its 2% target, the central banks are right.

If the inflation is not transitory, set to remain way above target, the central banks are making a catastrophic mistake.

If interest rates rise to the level of inflation, the consequences may well be catastrophic also. Bond crash which we discussed five years ago, real estate crash, bankruptcies of firms that depend on cheap money to remain solvent, and sovereign debt crisis for highly indebted countries with short maturities.

Could it be that when history is written 30 years ago that the Covid monetary expansion will be seen in the same light as the central bank's refusal to provide liquidity in the Great Depression? A historic mistake?