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On Friday, January 14, Lord Mervyn King joined Markus’ Academy for a lecture. King is a Professor of Economics and Law at NYU Stern School of Business and NYU Law. He has also served as Governor of the Bank of England and Chairman of its Monetary Policy Committee as well as Deputy Governor, Chief Economist, Executive Director and a non-executive director of the bank.

Watch the full presentation below. You can also watch all Markus’ Academy webinars on the Markus’ Academy YouTube channel.

Executive Summary

  • [0:00] Inflation is on the rise: how can there be a soft landing? Extremely low interest rates have caused high inflation, as many people had predicted. Small interest rate increases this year will not be enough to decrease inflation, suggesting that a soft landing will be difficult. Debt restructuring will likely be a major structural problem facing monetary and fiscal authorities in the next few years. Global effects will be nontrivial, as low-income countries that borrow in dollars may feel the effects of interest rate increases. Credibility is very important for central banks, and if people don’t hold the same 2% inflation expectations, it will be very damaging. The inflation anchor differs based on lived experiences, as Central Bankers or citizens who did not live through high inflation periods worry more about low inflation.
  • [24:36] What do you see as the role of models and the reaction functions of the central bank? The point of a model is to simplify a certain aspect of the world, so you can wrap your head around the idea. However, one main weakness of monetary policy in recent years has been the belief in simple models that do not properly factor in confounding agents, leading to suboptimal policy decisions. Overly simplified modeling may have given a false sense of security that inflation would always trend back to 2%, which could be why lenient inflation targeting policies were put into place. 
  • [31:11] How did inflation targeting begin, and how has it functioned? In the 1970s, people believed that the economy could run at a high level without inflation, and in the 1980s, first attempts at price stability began through monetary aggregates. By the 1990s, challenges with exchange rate targeting and monetary targets meant that inflation targeting made the most sense, which led to the standard 2% rate in the following decades. Transparency was important in the sense that people needed to understand why the banks were making these decisions, not simply publishing all proceedings on these matters. 
  • [47:44] What are some of the limits of inflation targeting? Fed predictions often vary based on perspective, which means that it does not always make sense to provide exact estimates. World events and financial crises have shown that it does not make sense to have a framework that gets easily overwhelmed by events. Many people believe that there is a natural rate of interest and unemployment. We may be able to use the natural rate of interest in modeling going into the future, which could be beneficial in creating policy.
  • [53:11] From current events, what is in store for the future of Central Bank Balance Sheets? Quantitative easing practices have been used whenever an event is taking place, and we need to assess whether everything requires a Central Bank response. However, during the Covid-19 crisis, banks were not contracting their balance sheets, meaning that any QE was increasing the monetary base, which may have been a cause of recent inflation. We must ask whether these stimuli are necessary in finding the optimal equilibrium, and whether the Central Bank should be involved or whether that compromises principles of independence.
  • [1:07:46] The Role of Central Bank independence. Central Banks have recently felt an onus to take action on some issues, but there are often great risks involved once the Central Bank feels the need to act on social issues or things that could be geopolitically complicated. 
  • [1:12:33] Central Bank Digital Currency. The House of Lords report called it “a solution in search of a problem,” believing that it could lead to financial instability and greater state surveillance. It is not feasible for many Central Banks at the moment, and many of the primary functions of CBDC are already done in the way things are currently done.