MNI: Central Banks Need Humble Approach After Covid Errors:G30

Central banks must learn painful lessons from errors made through the pandemic and return to basic economic stabilization to avoid domination by governments or financial markets, a G30 group of former officials said in a report Thursday.

The 60-page document is sweeping in criticism of many of the major tenets of central banking laid out since the 2008 financial crisis, and the main authors include three former policymakers: Jacob Frenkel of Israel, Raghuram Rajan of India and Axel Weber of Germany. The G30 is also chaired by former BOE and BOC chief Mark Carney and other members include former Fed officials Roger Ferguson and William Dudley.

Policymakers relied too much on inaccurate economic models and “misdiagnosed” supply and demand forces that drove up prices through the pandemic, the report said. Misguided focus on phantom deflation also constrained monetary policy when prices surged while extraordinary policies further strained credibility. (See: MNI INTERVIEW: Fed Needs Better QE Guardrails- Fed Adviser)

"We propose a humble approach to central banking," the report said. "The humble approach suggests that central banks should tilt their approach toward simpler and more transparent rules that preserve policy space rather than keeping the door open for unconventional measures that threaten to undermine their ability to act in the future."

KEEP EXPECTATIONS ANCHORED

Central bankers across much of the G7 in recent years have said they were humbled by joining "team transitory" when it came to inflation, while also defending keeping interest rates close to zero and ballooning their balance sheets even as inflation was flaring up. It's often been unclear exactly how central banks have reworked their formulas or embraced new ways of thinking to avoid repeating the misses raised in the G30 report and elsewhere. (See: MNI INTERVIEW: Senator's BOC Bill Seeks Rigor Not Rebuke)

Elevated government and private debts raise new pitfalls and the risk of "dominance" by politicians or investors over monetary policy, the report suggested. That makes it even more important to reconsider mission creep in favor of a return to a focus on stabilizing inflation, the wider economy and financial markets.

Future extraordinary policies should keep a stronger focus on a clear exit strategy to avoid entanglements from their side effects and to protect room for future action, the report said. Central bank independence could also be eroded by balance-sheet losses so monetary officials deploying QE should consider coordinating rate hikes and asset sales and whether to adjust interest paid on excess reserves, the authors found.

Other highlights:

• "Central banks misdiagnosed inflation when it occurred. The environment of weak demand and lack of robust stimulus in the wake of the GFC led them to fear deflation and the zero lower bound far more than inflation. Moreover, central bank inflation predictions relied heavily on models that implicitly assumed inflation would be transitory."
• "Central banks were confident in implementing both unconventional interest rate and balance sheet policies to stimulate growth, despite the fact that those measures would limit their policy space later on."
• "Central banks and governments may play a 'blame game' in which each attempts to avoid culpability for inflation in the eyes of the public."

Source: G30