Central banks will continue to provide downside protection and guarantees against asset price falls in order to avoid deflation – moves that have allowed equity market valuations to stay “over and above” fundamentals – but are no longer certain of their ability to achieve inflation targets.
“The faith central banks have in themselves is near the lowest I remember in my whole career,” Mr Butler told the JANA Annual Conference.
“Almost every conversation I have with central bankers over the last couple of years, there are reoccurring things: one, they have no faith in their models, or less faith than they have in the past. They have no faith in their forecasts, and increasingly have very little faith in their tools and ability to generate inflation.”
New central bank tools, including negative rates and employment targets, are also politically charged and need to be co-ordinated with the agenda of whichever government is in power. On several occasions over the last several months US President Donald Trump has called on the Federal Reserve to use the ‘gift’ of negative rates to soften the economic blow of COVID-19.
“Subtly, underneath the surface, you are gradually moving away from independent central banks,” Mr Butler said.
“Ironically at a time when central banks have the most doubt about their abilities, they’re at a point where they’ve never been more powerful for markets. They doubt their own ability, but the markets have full and complete confidence in central banks.”
Mr Butler anticipates significantly higher government intervention in the economy going forward, with the safety nets put in place to protect the labour market – including higher unemployment benefits and wage subsidies – being retained after the shock, providing a ‘guarantee to the private sector’ and helping raise inflation.
“I think there’s a high likelihood as we go forward that fiscal evolves into infrastructure spending and tax cuts, but those safety nets stay in place either implicitly or explicitly every time there’s a downturn,” he said.
