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Recent events revealed that central banks have less clothes on than assumed. When the Fed cut rates by 50 basis points, markets instantly started to recognize that fact, while many analysts still do not understand the far-reaching inflationary consequences of that cut.
The revealed central bank nudity could result in a larger than expected depreciation of paper currencies (first and foremost the USD) against real values (such as commodities) and will probably ultimately also translate into a rise in consumer prices. Only at that moment will monetary policy finally have to put on some clothes, in order to stave off hyperinflation. Do not be fooled by the current nakedness – in their basements, central banks have a large musty chest filled with clothes, unused since the times of Paul Volcker. As soon as consumer prices start to accelerate to the upside, central banks will have to dress. Double-digit rates, as predicted by Sir Alan, will then probably put an end to ever-rising asset prices.
Source: www.economicreason.com
What many analysts do not understand is what determines the “stance of monetary policy“. The current monetary policy interest rate, for example, is an unsuitable measure of the stance of monetary policy. The expected path of the policy rate, which is known from futures prices, is already more informative, however, it is still an incomplete measure. The most comprehensive measure of the stance of monetary policy is the full reaction function of the central bank, i.e. the full probability distribution of the future path of the policy interest rate. This distribution, however, is unknown and must be inferred from words and deeds of central banks.
Recent events revealed that the weight of financial stability in central banks’ reaction function is much heavier than was assumed previously. Recent central bank action therefore shifted that distribution significantly to the left (at least in the next few quarters). The revelation that the current and future financial market woes will be accommodated by central banks is thus equivalent to a strong expansion of the stance of monetary policy.
The revealed central bank nudity could result in a larger than expected depreciation of paper currencies (first and foremost the USD) against real values (such as commodities) and will probably ultimately also translate into a rise in consumer prices. Only at that moment will monetary policy finally have to put on some clothes, in order to stave off hyperinflation. Do not be fooled by the current nakedness – in their basements, central banks have a large musty chest filled with clothes, unused since the times of Paul Volcker. As soon as consumer prices start to accelerate to the upside, central banks will have to dress. Double-digit rates, as predicted by Sir Alan, will then probably put an end to ever-rising asset prices.
Source: www.economicreason.com