Monetary policy and Guy Fawkes lanterns

By Nick Hubble – For many dozens of years, central bankers have been managing the relationship between inflation and unemployment. Only to discover there isn’t one.

The last ten years proved the point. In fact, the relationship between inflation and unemployment has only held for a preciously short amount of time. And yet it continues to be the most influential economic theory around. That’s because it justifies monetary policy itself. The idea that governments can and must manage the economy.

I know that managing the economy through interest rates sounds like a stupid idea. But people used to believe in similar absurdities.

It’s all down to the Phillips Curve – the relationship between inflation and unemployment.

If unemployment is too high, inflation will be too low because workers aren’t cashed up enough to spend and push up prices. If inflation is too high, it’s because too many workers have too many jobs and too much income, which pushes up prices.

This theory is stupid. It ignores something called supply and demand. If prices rise because workers are cashed up and can buy more, then production increases and increases supply. That returns prices to a lower level. As commodity traders will tell you, the cure for high prices is high prices. It incentivizes supply. But to an economist, the cure for high prices is higher interest rates. Because they can’t help but meddle.

If central bankers can’t control inflation or unemployment, why put up with the problems they create? Like asset bubbles, debt booms, inequality and explicit backdoor bailouts for bankers that encourage absurd levels of risk? more>

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