Central bankers could learn from Pulp Fiction's ‘The Wolf’ to clean their mess

By Daniel Moss

In the final stages of the long boom that was upended by the pandemic, some acclaimed central bank alumni appeared on a stage in Atlanta and canvassed how it might all end and a recession begin. Former Federal Reserve Chair Ben Bernanke declared that growth is typically murdered by monetary authorities. Janet Yellen, his successor at the Fed, was more diplomatic: Business cycles usually don't just die of old age.

If the current global expansion comes to an end in 2024, policymakers will doubtless be left holding the weapon.

The cleaners then arrive, like The Wolf, the self-described problem solver played by Harvey Keitel in Quentin Tarantino’s classic movie Pulp Fiction. But here they are also the perpetrators, who realize they have been too successful at quelling inflation and have harmed growth more than anticipated in the process. Now they have to clean up the mess, and time is a factor. Reflexively, rate cuts quickly follow — along with promises to do better and learn from the experience. Markets forgive them and rejoice at easier money. Lots of cream, lots of sugar.

This cycle looks like repeating itself. Investors appear to have concluded that the coming year will be defined by reductions in borrowing costs after 18 months of relentless tightening. This view gained more fans in the past few days. Isabel Schnabel, a European Central Bank official who has been one of the most prominent champions of inflation busting, said price increases are undergoing a “remarkable slowdown.” Dour news on the jobs front strengthened expectations the Fed will soon be juicing the economy; Bloomberg Economics predicts a series of cuts beginning in March. The Reserve Bank of Australia reined in its hawkishness, and speculation that the Bank of Japan would end its experiment with negative rates in coming weeks has waned.

It all seems so easy. The big pivot that people were waiting for is at the door, to hear it from the bond bulls. Other important recalibrations in the past year, such as the Fed scaling down to quarter-point hikes and then pausing, didn't cut it. The central banks were still perceived as hawkish, and often sounded that way.

Now, with inflation retreating pretty much everywhere and fresh concerns surfacing about the vitality of key economies, monetary authorities appear poised to flick the switch to easing. This conviction could use some scrutiny. The degree of easing, assuming it comes, and the language that officials use to package it, will matter greatly. Policymakers still bear the scars of discovering belatedly that the spike in prices in 2021 was not so “transitory.” Though that particular word was deployed by Fed boss Jerome Powell to dismiss the prospect of runaway inflation, peers threw around very similar language. They then had to regain their credibility by ratcheting up borrowing costs at a clip unseen in a generation. Officials also haven't hesitated to point out that the big mistake from the bad old days of the 1970s was to relax too soon.

A lot depends on the stories central bankers tell themselves. A panel last week hosted by the Hong Kong Monetary Authority and the Bank for International Settlements offered some insights that rate-cut proponents would find sobering. Now free from the constraints of incumbency, former top officials dwelt on the reputational risks that the coming years hold for their successors. They are significant.

Speaking at the event, Philip Lowe, former governor of the RBA, framed contemporary developments as the opening stages in a new monetary era. As eventful as the past few years have been, the coming ones are going to be extremely difficult. In Lowe’s view, the period leading up to Covid, generally defined by low interest rates and barely recognizable inflation, is giving way to something more sinister:

This is why the current inflation test is so important, it’s so important we pass it...Central banks have to be able to convince people that inflation will return to target fairly soon. If they don’t, then the next time inflation moves away from target — and there will be plenty of examples — people won’t believe that it’ll come back.

Being caught out by another inflation spike would be extremely damaging, Jacob Frenkel, a former Bank of Israel chief, warned. He argued that the best way to ensure that such a steep increase in prices is, indeed, transitory, is to snuff it out when you see it, not debate whether or how it will pass on its own. Philipp Hildebrand, vice chairman of BlackRock Inc. and former head of the Swiss National Bank, gave monetary guardians good grades. But that shouldn't obscure the new environment. Instead of a “structural bias” toward easy policy that prevailed for decades, there will be in the future a similar bias the other way — toward tightening.

It's all very well to chastise the lords of finance for fighting the wrong war in 2021 when the warnings about inflation began in earnest. But they had been there before. In 2010, in the aftermath of the Global Financial Crisis, a group of mostly conservative economists and investors wrote to the Wall Street Journal predicting that quantitative easing would lead to a massive outbreak of inflation and debasement of the dollar. Neither happened at that time.

So which conflagration will be the feature in 2024? A vanilla slowdown accompanied by a welcome respite in inflation? They know how to fix that. It's in all the textbooks. Just cut rates. It would be nice if fiscal policy joined in, though that is slow and replete with the political compromises that central bankers profess to be above. Or is the trauma from the “transitory” stumble too great and too fresh?

The case for easing in 2024 looks promising. But the reductions may be grudging and not as deep as wished for. Like John Travolta’s movie character Vincent Vega, policymakers don’t like being told what to do. But should a desired moderate economic slowdown turn into a pronounced downturn, we know who will be on the case. The same folks who did the killing — with the best of motives.