Charles Goodhart: ‘Demography is going to make life worse and worse and worse’

{"text":[[{"start":null,"text":""}],[{"start":8.3,"text":"Good morning. Thirsty for good news? Here’s some: Germany’s finance minister has got behind the idea of shifting power upwards to the EU financial regulator. “The goal of . . . a more resilient Europe is, for me, more important than clinging to national interests,” Lars Klingbeil said. Much more of this will be needed to fix Europe’s competitiveness problem in finance and elsewhere, but every journey starts with one step. Email us: unhedged@ft.com. "}],[{"start":34.900000000000006,"text":"Friday Interview: Charles Goodhart"}],[{"start":37.60000000000001,"text":"Charles Goodhart, born in 1936, is one of the leading economists of his generation. He worked at the Bank of England from 1968-1985 and served as an inaugural member of its Monetary Policy Committee from 1997-2000. From 1985-2002, he was a professor at the London School of Economics, where he helped to set up the Financial Markets Group. Over a light lunch and chocolate Magnums in his home this week, he spoke to Unhedged about demographics, public finances and monetary policy. The text has been edited for clarity and brevity."}],[{"start":77.30000000000001,"text":"Unhedged: Let’s start with the thesis of your new book with Manoj Pradhan, The Unanchored Central Banker. If the earlier book, The Great Demographic Reversal (2020), was a kind of prophecy that demographic trends would lead to structurally higher inflation, has that scenario now come to pass?"}],[{"start":94.30000000000001,"text":"Goodhart: It wasn’t a prophecy. It was based on the fact that there had been a remarkably beneficial supply shock in the form of what had been happening in the population and through the inclusion of both China and eastern Europe into the world trading bloc. And you added to that the decline in the fertility rate, which had a double effect. It meant that far more women were entering the labour force. That was a massive improvement in the availability of labour. And inevitably, it meant that goods prices and also labour costs were held down."}],[{"start":127.50000000000001,"text":"It was obvious, if you looked at the data carefully, that this was going to reverse, because the increase in the labour force was going to go down, the number of old people was going to go up and the dependency ratio would worsen."}],[{"start":140.45000000000002,"text":"Now, we wrote the second book because one of the things that had happened in the intervening five or six years was that the fiscal position had worsened dramatically, much more than we’d ever thought. The worsening of the fiscal position, combined with the adverse developments of demography, is actually going to worsen the situation more than we had actually realised."}],[{"start":161.3,"text":"The argument in a nutshell is that fiscal policy has become so unsustainable, and so precarious, that monetary policy cannot easily work, particularly not in its regular form of raising interest rates."}],[{"start":175,"text":"Unhedged: You said that you think fiscal policy will stop monetary policy from working in its regular form. Is that about interest rates being inadequate to the task or something to do with fiscal dominance?"}],[{"start":186.8,"text":"Goodhart: I don’t think interest rates are as strong a tool as many in central banks like to think, because I don’t think the decline in inflation that occurred from the 1990s through to 2020 was due to central bank activity. But, nevertheless, interest rates do have a significant influence."}],[{"start":202.9,"text":"The problem is that fiscal dominance is going to constrain the ability of central banks to use interest rates to the extent that they may desire. From the 1990s down to about 2019 the trend in inflation and the trend in interest rates was down. There’s no government in the world that is unhappy with downward trending interest rates, both nominal and real. And why not? It makes life a lot easier. So central bank independence was never really seriously challenged during this period."}],[{"start":231.35,"text":"When we’ve got fiscal problems, increases in interest rates make life difficult for governments. [Donald] Trump is the obvious example. But this is going to become more general in all advanced economies. Central banks are going to be subject to much greater pressure. Their freedom to use interest rates, as they might want, to bring inflation back to target is not going to be the same as it was earlier."}],[{"start":254.2,"text":"Unhedged: Would it be possible to have greater fiscal-monetary co-operation, or at least some kind of central bank acknowledgment of the difficult fiscal situation, without the central bank fully conceding to fiscal dominance?"}],[{"start":267.2,"text":"Goodhart: That’s a very serious question. It will have to be faced. What do you do? There are alternative ways of trying to constrain demand, and therefore inflation, by various forms of financial repression, usually of the banking system. Or do you just raise interest rates and ignore the politicians? Or do you try to ease things for politicians by undertaking other kinds of restraints, which have disadvantages and distort the system? Or do you just resign and say, there is no good outcome? That, in a sense, is a bit cowardly. "}],[{"start":301.34999999999997,"text":"Unhedged: Of course, the disinflationary potential of AI is a current theme in the market, not least because of Federal Reserve chair Kevin Warsh’s argument that this will allow him to cut interest rates. Do you think AI could deliver a positive supply shock on par with China and eastern Europe’s entry into the world trading system?"}],[{"start":321.45,"text":"Goodhart: The answer to that is that nobody knows and certainly I don’t. But if you look at the effects of technological breakthroughs, they haven’t occurred in a rush. They have been slower to develop. And actually at the moment the effect of AI is inflationary through the expenditure on data centres and energy usage. The change that would, I think, massively affect future fiscal issues is not so much AI, but whether the medical profession can deal with dementia and the number of old people needing care."}],[{"start":350.7,"text":"Unhedged: Do you think markets and central banks are now accurately factoring in the risk of structurally higher levels of inflation due to demographics?"}],[{"start":359.45,"text":"Goodhart: When we wrote the last book, we were one of the very few — I won’t say the only ones — to point out the importance of demography. Now everyone knows about demography. But I don’t think people have actually come to grips with how a society works when the dependency ratio is so lopsided. From now on, demography is going to make life worse and worse and worse."}],[{"start":381.45,"text":"Unhedged: The major central banks all appear to have committed to running much larger steady-state balance sheets than they did before the global financial crisis. This is driven largely by financial stability considerations. What are your views on the use of the central bank balance sheet for financial stability purposes?"}],[{"start":399.59999999999997,"text":"Goodhart: So long as the fiscal situation is unsustainable there are bound to be periods of sharp declines, perhaps crises, in bond markets. In support of financial stability, the central bank is almost bound to step in. The question is, what actually triggers it to step in? [Former UK prime minister Liz] Truss was a fairly obvious trigger. The question of when the central bank should step in is a very difficult one. But it is likely to step in more frequently. There is quite a long passage in the book about the central bank quite likely having to step in on a fairly regular basis in order to keep the long-term bond market relatively stable, but the degree and extent of that support needs to be carefully considered."}],[{"start":440.99999999999994,"text":"Unhedged: Debt management agencies in the US and UK have been shifting issuance towards the short end to manage the fall in demand for long-duration bonds. Is this good or bad for fiscal sustainability?"}],[{"start":453.29999999999995,"text":"Goodhart: It’s only right to go short if you expect interest rates to go down. It’s wrong to go short if you expect interest rates to go up. Given the degree of fiscal instability and with what’s happening to the US fiscal deficit because of Iran, demographics and climate change, the likelihood is that interest rates are going to go up, not down. The choice of going short may be forced upon [Treasury officials] by a lack of demand for longer-term bonds, but it doesn’t make life easier. The more you go short, and interest rates go up, the more you get killed immediately."}],[{"start":487.04999999999995,"text":"Unhedged: You’ve written about reforming accountability for bank failures, arguing that bank directors should face personal liability for an institution failing on their watch. US and UK regulators are currently weakening several of the flagship post-GFC banking reforms. Do you think your proposal would provide a “simpler” alternative to capital regulation and bail-in debt?"}],[{"start":510.19999999999993,"text":"Goodhart: I don’t think that the proposal will gain traction because those in senior positions won’t like it. And it’s not that easy to do. A failure usually occurs after a lengthy period of things not going very well. So it’s not necessarily the person in charge at the time of failure who should be held primarily responsible."}],[{"start":528.5999999999999,"text":"My view is that information is power. The people that have the most information are those in charge of the bank, including the really large shareholders. Small shareholders have virtually no information, except what the bank chooses to give them. Regulators have quite a lot of information. Large depositors don’t have very much information. So, the idea that you can rely on bondholders and large depositors, I think, is invalid because they don’t have the information. There’s a very considerable failure in economics, particularly in monetary economics, to discuss who has what information. Too many of the models assume that everybody has complete information about everything. Those models are lunacy because that doesn’t hold."}],[{"start":571.6499999999999,"text":"Unhedged: During your life as an economist, you’ve witnessed a succession of policy regimes, including exchange rate and inflation targeting — both before and after central bank independence. What comes after inflation targeting?"}],[{"start":586.6999999999998,"text":"Goodhart: It depends on the fiscal position. The central bank cannot operate by itself effectively if the fiscal position is unsustainable. Until the fiscal position gets rectified we’re in serious trouble."}],[{"start":600.4999999999998,"text":"If the fiscal position is totally out of whack, there’s not much a central banker can do on their own. That’s why we called the book the “unanchored central banker”. The anchor they had of g (the growth rate) being greater than r (the interest rate) has gone. Unless AI waves a magic wand things are going to get very difficult."}],[{"start":619.5999999999998,"text":"One good read"}],[{"start":621.4999999999998,"text":"Gross domestic human flourishing"}],[{"start":null,"text":"

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