Central banks need to prepare because global stock markets and real estate are overvalued, while leverage is near record levels for households, corporations, banks and governments.
NEW YORK (Project Syndicate)— Since early 2020, central banks across the advanced economies have had to choose between pursuing financial stability, low (typically 2%) inflation, or real economic activity. Without exception, they have opted in favor of financial stability, followed by real economic activity, with inflation last.
As a result, the only advanced-economy central bank to raise interest rates since the start of the COVID-19 pandemic has been Norway’s Norges Bank, which lifted its policy rate from zero to 0.25% on Sept. 24. While it has hinted that an additional rate increase is likely in December, and that its policy rate could reach 1.7% toward the end of 2024, that is merely more evidence of monetary policy makers’ extreme reluctance to implement the kind of rate increases that are required to achieve a 2% inflation target consistently.
Today’s risk-asset valuations are utterly detached from reality.
Central banks’ overwhelming reluctance to pursue interest-rate and balance-sheet policies compatible with their inflation targets should come as no surprise. In the years between the start of the Great Moderation in the mid-1980s and the 2007-08 financial crisis, advanced-economy central banks failed to give sufficient weight to financial stability. A prime example was the Bank of England’s loss of all supervisory and regulatory powers when it was granted operational independence in 1997.