WHY INFLATION WILL REMAIN A PROBLEM, PART 2
GOVERNMENTS ARE QUICK TO ADDRESS THE DOWNSIDE RISKS TO THE BANKS AND THE FINANCIAL SYSTEM. THIS IS DUE TO A NUMBER OF FACTORS, BUT PRIMARILY IT IS DUE TO A CHANGE IN THE PSYCHOLOGY OF GOVERNMENTS REGARDING BANK SOLVENCY AND ECONOMIC GROWTH.
SIMULTANEOUSLY, THEY HAVE BECOME SLOWER TO MOVE TO STOP INFLATION FROM BECOMING EMBEDDED IN THE SYSTEM.
Now that they recognize inflation is becoming a problem, they have begun to address it…but in words only. Thus far, U.S. Federal Reserve has spoken about the possibility of higher interest rates, but they have done nothing. U.S. interest rates are lower now than when the inflation rate was almost 2% per annum lower. Higher inflation should mean higher interest rates, but thus far it hasn’t. The ECB has also recognized inflation is higher than their targets, but thus far has only spoken of instituting higher rates.
Government officials have become afraid to not limit the downside risks to their economy due to social and political pressure. The days of the hard nosed, tough central bankers in the U.S. and many countries has ended. Inflation, which was a specter that stalked the world in the 1970’s, has been pushed to the back of the institutional memory of politicians and bureaucrats who run the day to day activities of government. The days when inflation, and wages adjusted to inflation, caused havoc in the 1970’s are remembered by some of the older financial types, but not by government as a whole. As a result, people in the developed and developing world are slow to act to restrain inflation. This slowness to restrain it causes inflationary psychology to become imbedded in the public mind. As we will discuss in future memos this can be a serious problem.
Another major issue is that the U.S. and Europe have become more social democratic or socialist in the governmental policies in the last thirty years. Thus, an institutional bias by government toward protection of the public at all costs has risen. In other words, the institutional bias that existed in the U.S. in the 1970’s that said that the individual was at least partly responsible for their personal financial future has eroded. In the 1970’s, I do not recall anyone thinking that it would ever be OK for the government to take over a bank like Britain did when it bailed out Northern Rock; publicly stating that it was making good all deposits…even those well in excess of the insured maximum. In fact, many crises of the seventies were correlated to a major bank failure. At those times, people who had deposits in excess of insured amounts were just out of luck.
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