Central banks and the looming financial reckoning

Since early 2020, central banks across the advanced economies have had to choose between pursuing financial stability, low (typically 2%) inflation, and real economic activity. Without exception, they have opted in favour of financial stability, followed by real economic activity, with inflation last.

As a result, the only advanced-economy central bank to raise interest rates since the start of the Covid-19 pandemic has been Norway’s Norges Bank, which lifted its policy rate from zero to 0.25% on Sept 24. While it has hinted that an additional rate increase is likely in December, and that its policy rate could reach 1.7% towards the end of 2024, that is merely more evidence of monetary policymakers’ extreme reluctance to implement the kind of rate increases that are required to achieve a 2% inflation target consistently.

Central banks responded to the Covid-19 pandemic by pursuing unprecedentedly aggressive policies to ensure financial stability. But they also went far beyond what was required, pulling out all the policy stops to support real economic activity.