Apr 22, 2011 06:42 PM

As Inflation Surges, Central Banks Run Amok

Inflation is rising around the world, and none of the major central banks have shown serious interest in containing it. To prosper now, under these inflationary conditions, one needs thick skin.

The Bank of England has the thickest skin of all: It no longer gives excuses for ignoring inflation. The U.S. Federal Reserve is constantly inventing new theories while trying to explain away inflation, and while trying to justify its QE2 quantitative easing project despite inflationary signs aplenty.

The European Central Bank has the thinnest skin of all, and recently raised interest rates to defend its credibility in targeting price stability even though, unfortunately, the ECB won't be able to maintain this stance. The Bank of Japan is still shy, but it will have to out-QE the Fed to help its government pay for post-earthquake reconstruction.

Price stability is supposed to be central banking's main goal. But these days, central bankers think they're super heroes who should rescue the world and make everyone happy.

Inflation, since its negative effects are spread thin and take time to materialize, is ignored. Today's central banking is about so many things except inflation. This is why inflation will worsen for a long time to come. Indeed, inflation is the main theme for the current decade. A change will occur only when the current generation of central bankers is replaced.
Inflation's Hold

When western governments decided to bail out their bankrupt financial institutions in 2008, I foresaw inflation ahead. I argued it would start with commodities and in emerging economies, and then spread to developed economies. But now it seems inflation has already taken hold in developed economies.

The euro zone inflation rate reached 2.4 percent in February and 2.7 percent in March year-on-year, marking the third and fourth months that the rate topped the ECB's 2 percent target. More importantly, it's been on a solid upward trend for the past two years. Inflation's dip in 2008 seemed a temporary phenomenon due to negative demand shock. Actually, structural forces have been inflationary for a long time.

The U.S. Consumer Price Index increased 0.5 percent in March from the month before and 2.7 percent from the same month 2010. The index has risen an average 2.7 percent over the past 12 months, much higher than the Fed's assumed target of 2 percent. However, the Fed insists on focusing on core CPI, which excludes food and energy. That indicator averaged a 1.2 percent increase over the previous 12 months.

The problem with the Fed's view is that its policy is partly, if not mostly, the reason for a rapid increase in food and energy prices. If it continues on this policy track, this price trend will continue. And core CPI will eventually catch up with general CPI.

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