Inflation has reached levels not seen these past 40 years and people are mad as hell. They’re coming for the central banks who, at a minimum, didn’t see it coming, let it happen when they shouldn’t have or – the angrier people say – actually caused it.

But before reaching for your pitchfork and joining the mob, consider a few mitigating facts. First, it’s not just the central bankers that didn’t see high inflation coming. Virtually nobody did. In July 2021 the Wall Street Journal’s regular poll of US forecasters found that inflation in June 2022 was expected to be 2.7%. Of the 62 who put in a guess, only four thought it would be 4% or more and the highest guess was 4.5%. In the event, it was 9.1%.

“Before reaching for your pitchfork and joining the mob, consider a few mitigating facts.”

Some of this massive miss is forgivable. Nobody knew Vladimir Putin was going to invade Ukraine: cue for soaring energy, wheat and metals prices. Few expected COVID-19 would still be gumming up supply chains to the extent it is. And some inflation may be going away already: world commodity prices are down by some 10% from their peak in June.

But not all of it can be hand-waved away as unpredictable or transitory. In Australia and New Zealand, food and energy has only been about a fifth of the inflation story, and other stuff makes up the vast bulk of it. For countries on the receiving end of Russian gas prices, it’s a different story, as the graph below shows, but here at home it’s a much wider phenomenon than just petrol and tomatoes.

There has indeed been a pick up in underlying inflation: the latest ‘non-tradables’ (roughly, domestically generated) inflation rates in Australia and New Zealand are 5.3% and 6.3%, well above what the two central banks are supposed to manage.

Click image to enlarge. Graph: How much of our inflation is down to food and energy?. Source: OECD.Stat

Ready, set... off the mark

Criticism has come from every quarter. One good example was the analysis recently put out by two Kiwi economists – one a former Reserve Bank of New Zealand (RBNZ) governor – bluntly called How Central Bank Mistakes After 2019 Led to Inflation.

Central banks, they say – and they mean the bunch of them globally, not just the Reserve Bank of Australia (RBA) and RBNZ – eased too much when COVID-19 hit, and stayed too loose for too long: “Central banks overdid interest rate cuts and the scale of their quantitative easing, and many continued large asset purchase programs when it was clear from the tightness of the labour market and rise in bond yields from late 2020 that their economies were stronger than forecast and that inflation pressures were starting to build.”

Why, the authors ask, did the banks make those errors? After years of keeping inflation under control, they’d become complacent; their models of the economy weren’t good enough; they’d forgotten that monetary policy has long and variable lags, and can’t be used to fine-tune what happens; they’d taken their eye off their day job and got too involved in extranea; they’d been lumbered with multiple objectives beyond inflation; and they may not have been as politically independent as they should have.

Sounds like a slam dunk case for the prosecution, doesn’t it, and unsurprisingly there are now reviews being set up all over the place. Aussie Treasurer Jim Chalmers in July launched a broad one into the conduct of monetary policy, headed by three independent experts. The RBNZ’s in the throes of its first legislatively-required five-yearly review of its monetary policy remit (the operating guidelines set for it by the government). Both banks are also doing their own internal self-reflection.

One important point risks being missed. Central bankers weren’t operating all on their owneo through COVID-19. When the economic patient came down with the virus, sure, the monetary response team was there with warm blankets and maybe too many stiff brandies. But so was the fiscal response team with its log fire and hot soup. Was it any surprise the patient overheated?

Vodka in the fruit punch

It’s suggestive that the developed countries with the worst inflation outcome – the US, where it hit 9.1%, and the UK, where the Bank of England says it’ll hit 13% – were among the ones with the biggest fiscal COVID-19 responses. Fiscal and monetary policy needed to be better coordinated: we didn’t need two hosts putting vodka in the fruit punch.

That said, our central banks do have some questions of their own to answer. Their current economic models are like Formula 1 cars – precisely engineered with the latest technology, but no use off-road or in wet conditions: they need more utes. They haven’t got a good enough handle on how the money supply works through the economy – at a time when they were boosting it with their ‘unorthodox’ monetary policy instruments.

At its peak in New Zealand ‘broad’ money growth peaked at a 12.2% rate (December 2020), and in Australia it hit 12.7% (January 2021). It looks as if they got more inflationary bang for their buck than they’d expected: they need to find out why. And both Martin Place in Sydney and The Terrace in Wellington ought to figure out ways of getting a greater range of tyre-kicking expertise onboard. The RBA, for example, has fessed up to being too slow to react: a few more hawkish voices in the policy discussion might well have helped.

No doubt the various reviews will have further improvements, and we’re seeing other useful responses. Every developed economy in the OECD (Organisation for Economic Co operation and Development), bar two, reports monthly inflation numbers, as do quite a few of its developing members (Chile, Colombia and Turkey, for example).

The two missing? Yep: Australia and New Zealand. It’s a basic omission and very unhelpful when inflation takes a quick turn for the worse and you only find out later. In good news, the ABS in August brought out a new monthly inflation ‘indicator’ (i.e. not yet a ‘proper’ official statistic), but it does the job just fine and tracks the ‘real’ CPI pretty well. New Zealand needs to pull finger, too.

There are radicals in the marching mobs who’d go further. They’d abolish our current inflation targeting regime, or rein in the independence of the central bank ‘experts’. It’s way too early for that: let’s figure out how we lost the game before we change the rules.

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