🔔 "We Now Understand *How Little* We Understand About Inflation"

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"We Now Understand How Little We Understand About Inflation" said Jerome Powell, Chair of the Federal Reserve, central bank of the largest economy in the world.

The same central bank that sits at the heart of the global monetary system, issues lots of that greenish coloured paper that everyone always needs when sh*t hits the fan, no matter how many times it's pronounced dead by economic commentators...

Yeah THAT Federal Reserve.

Powell dropped this bombshell on a panel yesterday with the head of the ECB, the Bank of England, and the Bank of International Settlements. Everyone had a little chuckle at his joke, the host Francine Lacqua replied "that's not very reassuring" and the conversation quickly moved on...

Now, I LOVE these gatherings. Not because I'm a monetary policy nerd or anything like that (I am a bit). It's because they let their guard down.

In the company of other central bankers, they can all confirm their priors, get fully into groupthink mode and sometimes... They say the quiet parts out loud.

The new consensus was confirmed in the usual places...

Under normal circumstances, this would be the perfect time to take the opposite trade. By the time policymakers are changing tact it's already in the price. Peak inflation!  

Five year inflation expectations are falling everywhere at the same time as central bankers are signalling a brand new world of higher structural inflation. 👇

But the current situation just isn't that clean. Even as we head unerringly towards recession...

It's really not clear what kind of recession it'll be. The only thing that seems 'certain' is that a return to the old, low-inflation regime isn't on the cards any time soon.

See, the old regime was driven by a combination of Disinflationary forces such as new, efficient technologies, high Debt and ageing Demographics. Triple D.

As much as any of that though, it was driven by abundance and stability. An abundance of cheap energy (US shale, Russian gas), an abundance of cheap labour (Eastern Europe, China) and a stable, globalising world economy, where expanding trade was the over-riding goal.

The lesson? A world of abundance and stability is one where it's hard to generate inflation.

Powell think that world's gone for now 👇

We'll come back to the bolded points near the end. Lagarde echoed the sentiment:  

Powell summed it up:

So how did they get inflation sooooo wrong? I mean, it wasn't just their response to it, the models and forecasts were all way off.

Powell even pointed out that something was missing in their data for the past 40 years: "a collapse of the supply side".

BIS head Agustin Carstens had the final word: "As economists, we need to do better at understanding aggregate supply. We were trained under understanding aggregate demand, and we know how to respond to demand."

Here's the clip 👇

Despite acknowledging the supply side issues, central banks are going to aggressively tighten to destroy demand anyway, because what else can they do?

Which is why a recession is practically inevitable. But what if they take it too far? 👇

So, let's presume they can successfully destroy demand and put economies into recession. What next?

If inflation remains above target (it probably will), do they keep hiking?

A recession won't fix supply side issues. Arguably it would make them worse. Business investment/CAPEX typically reduces as the economy shrinks....

Going right out on a limb here, could central banks look to fix the supply side by working in tandem with governments?

Look at the earlier quotes in that context 👇

So, here's how it plays out. Governments get it in the neck from the citizens for high inflation. They blame the central banks who respond that they can't affect the supply side and that's the governments job.

Governments: "But we don't have any money, can't raise taxes in a recession and borrowing costs are getting higher and higher..."

Del-Boy enters the room 👇

I used Powell purely because of that jacket. It could happen in any country, but the eurozone is clearly most in need. This is from the Macrodesiac discord earlier today 👇

The eurozone is also the least likely to do anything before a proper, PROPER crisis. On that note, this is the only anti-fragmentation plan so far... 🤦‍♂️👇

Donors?! There was no better name than DONORS?! Can tell this plan was made by academics. Zero marketing skillz.

Summing up, now that central bankers are becoming more aware of the supply side issues and perhaps the potential need for domestic capacity to be increased as globalisation retreats, I think it's only a matter of time before the fiscal and monetary branches join hands to 'fix' the recession they're about to create.

The immediate issue is undoubtedly energy. There'll be no return to a low inflation world unless energy supply increases. And that'll need investment, stable policy and government backing, whichever form it takes.

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