A central-bank failure of epic proportions

By R.A. | WASHINGTON

I'd LIKE to say a bit more about the policy side of things given the state of the world economy. There is a great deal of attention paid to fiscal issues, and certainly fiscal issues deserve scrutiny. Greece, Ireland, and Portugal have little choice but to embrace swingeing short-term austerity, but massive short-term cuts in places like Spain and Italy are foolish and counterproductive. Maybe Germany and France can't be talked into substantial fiscal stimulus but, again, focusing fiscal consolidation efforts on the long-term and practicing a sort of benign deficit neglect at this moment of crisis seem the smart options. In America, the fiscal situation is extraordinarily frustrating. Each day, Treasury yields touch unbelievable new lows. It would certainly seem a very good opportunity to undertake, in scale, any capital investments the government has been putting off, and there are many. Congress isn't doing that, obviously. Instead, paralysis reigns and may produce a massive fiscal contraction at year's end, on top of which may come a disastrous debt-ceiling battle.

I reserve my greatest frustration for central bankers, however. Politics is always hard, central banks are supposed to be free to act independently of the political sphere, and monetary policy can largely offset fiscal missteps. Given this, and given the state of the world economy, the behaviour of the European Central Bank and the Federal Reserve is simply inexcusable.

The ECB's failings are perhaps the more understandable given the terrible political and fiscal institutions arrayed behind it. Yet the extent of the potential catastrophe over which it seems eager to preside is such that its actions are less forgiveable. The euro zone is in a recession that seems to be gathering force. Inflation in the euro zone is falling steadily, and given the ECB's obsession with headline figures it should be quite worried about the looming deflationary impact of tumbling commodity prices. At the same time, unemployment is rising for the euro zone as a whole and across most of its member nations—though not, for the moment, in Germany. Unemployment rates across the south are particularly bad. Over the past year, unemployment rates have risen by over five percentage points in Greece, nearly four percentage points in Spain, and by more than two percentage points in Italy and Portugal. The upward march is on in Belgium, France, and the Netherlands, as well.

The ECB's reaction has been stunningly limited. Its benchmark lending rate has stood at 1% for months. Its long-term refinancing operations were a bold step that prevented a financial disaster. It has since stood by, however, as financial conditions have rapidly deteriorated. Bank runs are seemingly developing across much of the periphery, monetary-policy transmission channels are breaking down, and the ECB is standing pat. One ought to hand Mario Draghi a fiddle. It is no surprise that ECB officials are wary of doing more without decisive action from political leaders, to shore up banks, extend euro-zone-wide banking institutions, and perhaps clear its way to buy sovereign bonds directly. As has been pointed out many times before, if the ECB is determined to wait on all of that to take decisive action, it may wait itself out of a currency to manage.

And then there is the Fed. Ben Bernanke has managed to innoculate himself against charges of doing too little, among much of the press anyway, by stepping in repeatedly when things look particularly bad. Yet the Fed bears the greatest responsibility for America's pathetic recovery. Mr Bernanke has systematically avoided his own good advice about how to stimulate at the zero lower bound. The Fed's interventions have been limited and seemingly designed to ignore the powerful expectations channel; at no point have breakevens shown inflation expectations steady at even pre-crisis levels when expectations above pre-crisis levels are what the current situation demands. Despite the obvious importance of inflation expectations for recovery at the ZLB, the Fed has behaved as if it's operating under a 2% inflation ceiling, rather than a target. It repeatedly stops pushing the economy forward as soon as it seems likely that the economic trajectory will carry inflation toward 2%. With plenty of slack remaining in the American economy, this strategy inevitably produces a return to disinflation at the slightest breath of trouble from abroad.

So here we are, with many of the world's larger economies facing difficulty, with high unemployment common across the rich world, with financial conditions deteriorating, and with political systems paralysed. Markets are fleeing into the few assets that look safe, commodity prices, equities, and currency movements are all indicating a large and sustained drop in demand expectations. And the world's most important central bankers are confused over whether or not to act out of concern over inflation and seeming terror that inflation might ever rise to and stay for a while at, oh, 3%. They seem horrified by the idea that central banks might—might—need, at some future point, to bring inflation expectations back into line, as they did in the early 1980s. Never mind, of course, that the experience of the early 1980s was a sunny day in the park compared to what the rich world has gone through since 2008, and heaven compared to what might loom ahead.

It is infuriating and inexcusable. It is dereliction of duty.