It's time for central banks to ditch the dead economic model

Spriha Srivastava
Federal Reserve Board Chairwoman Yellen Gives Semiannual Monetary Policy To Senate Committee
Source: Getty

Central banks are suffering a major headache, and only an exit from QE will solve it.

The death of a major economic concept is riling many economists and analysts. A fundamental philosophy, known as the Phillips Curve, shows that inflation and unemployment have a stable and inverse relationship.

But with central banks using artificial ways to pump money into the economy, many economists think this inverse relationship is dying, or rather “flattening”.

Low wages and temporary jobs add pressure on workers. That in turn leads to less spending power in the economy, even though the level of unemployment might be falling.

This is not great news for central bank policymakers across the world who have been pumping artificial money into the system over recent months to bring the global economy back to its pre-2008 crisis days.

Ever since the global financial crash, central banks have pegged their monetary policy on these two pillars – inflation and unemployment. While they have been successful in trying to bring the level of unemployment down, inflation hasn’t edged up to the target many of the central banks had set earlier.

Recent economic data across the US and Europe has shown that, while unemployment seems to be cooling down, inflation is lagging.

As a result, institutions like the European Central Bank (ECB) have recently had to lower their inflation targets. In its Governing Council meeting in July, the ECB discussed at length the disconnect between inflation and employment in the Eurozone economy, attributing it to a number of structural factors such as changes in labour markets, work contracts and wage-setting processes.

But policymakers have still not been able to find a solution out of this deadlock. The answer lies not in lowering targets, but in slowly taking their foot off the accelerator.

Perhaps it is time for central banks to gracefully exit the long and arduous process of quantitative easing before the scars it leaves behind are too tough to handle.

Alberto Gallo, head of macro strategies and manager of the Algebris Macro Credit Fund, told CNBC last month that central banks should look at removing artificial stimulus because it is becoming less useful and has side effects. He said an adequate policy buffer needs to be built to deal with future risks.

Central banks, however, have always been very vague when communicating, especially when addressing questions like the dying Phillips Curve.

One would expect that policymakers would have exchanged notes in order to coordinate their timely exit when they met at the Jackson Hole Symposium last month. But will we ever know? Or is it the waiting game all over again?

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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