Why are central banks finding their job so hard to do? A common view is that this is because they are imbeciles. People who assert this insist that central banks need to keep interest rates in line with their historic norms. This is wrong, because historic norms are irrelevant. The questions are why and what this implies for our economies.
A paper by Atif Mian, Ludwig Straub and Amir Sufi at the Jackson Hole monetary conference on 27 August illuminates this issue. It reaches a conclusion, already suggested in their earlier work: the principal explanation for the decline in real interest rates has been high and rising inequality and not demographic factors, such as the savings behaviour of the “baby-boom” generation over their lifetimes, as some have argued.
The analysis starts with estimates of the real “natural rate” of interest, a concept that goes back to the Swedish economist Knut Wicksell. The natural rate, he explained, balances demand and supply in the economy, which shows itself in stable prices. The modern doctrine of inflation targeting has descended from this idea. Crucially, however, estimates of this rate for the US show a fall from about 4 per cent four decades ago to around zero now.