The Age of the Unanchored Central Banker - Book Summary

The Age of the Unanchored Central Banker — Inflation, Demographics, and the End of Cheap Everything

Thirty Years of Taking Credit for the Wrong Thing

A new book by economists Manoj Pradhan and Charles Goodhart called The Unanchored Central Banker makes an argument that should make central bankers uncomfortable. For three decades, they argue, central banks in the US and Europe were taking credit for a structural decline in global prices that had almost nothing to do with their policy decisions. They had the wind at their backs. They mistook it for the power of their own legs.

The wind they are talking about is demographics. From roughly 1990 onwards, the global economy benefited from a once-in-history set of circumstances: baby boomers entering peak working age, sharply rising female labour participation, and then the entry of China and Eastern Europe into global trade. This effectively doubled the size of the global labour force within a generation. More workers meant lower wages. Lower wages meant lower prices. And all of that happened regardless of what interest rate the Federal Reserve chose to set.

Central bankers looked at this and concluded that keeping inflation low was a testament to their sophisticated management of monetary policy. The reality is they were passengers in a car with a very strong tailwind, congratulating themselves on how fast they were driving.

China Put the Phillips Curve in a Coma

For anyone who has studied economics, the Phillips Curve is a foundational idea. Dating back to 1958, it describes the relationship between unemployment and inflation: when workers are scarce, wages rise, and prices follow. For twenty years this relationship appeared to have broken down. Unemployment fell to historic lows across the developed world and inflation barely twitched. Central bankers and economists started writing papers about the death of the Phillips Curve. They concluded they had somehow conquered the business cycle.

Pradhan and Goodhart argue the Phillips Curve was never dead. China had just put it in a coma.

The key insight is that there have always been two separate inflation dynamics running simultaneously. The first is domestic services inflation, your hairdresser, your plumber, your GP, the people who have to physically be where you are. Their prices are driven by your local labour market, and that relationship never actually broke down. Services prices kept rising steadily throughout the entire period.

The second dynamic is goods inflation, the physical stuff you buy. And for thirty years, this was essentially outsourced to Chinese factories. When you move most of your manufacturing to a country with dramatically cheaper labour, the price of physical goods falls year after year. That goods deflation was so powerful that it masked the services inflation running beneath it. The average looked fine. The underlying picture was not.

What this meant in practice is that central banks in the US and Europe were quietly outsourcing their inflation targets to Chinese factory workers. Politicians got to enjoy solid growth with low borrowing costs. Consumers benefited from steadily cheaper televisions, clothing and electronics. Nobody had to make any difficult decisions because the average kept looking reassuringly low.

That era is ending. China's own population is ageing faster than almost any major economy. Its workers are moving out of export manufacturing and into domestic services. Tariffs and trade barriers are now actively blocking whatever cheap goods China still produces from reaching Western consumers at the old prices. The structural tailwind that kept global inflation suppressed for thirty years is not just fading. It is being actively reversed by demographics, by geopolitics and by deliberate policy choices.

The Bill Is Already Here

This is not an abstract problem for future generations. The bill is arriving now.

US and UK inflation both hit 3.3% in March. The IMF has warned that even a ceasefire tomorrow would not immediately resolve the problem, because fertiliser costs, diesel prices and the surcharges from rerouting shipping are already locked into supply chains and will work their way through to consumer prices over the coming months regardless.

The US government faces a specific and deepening problem. Interest payments on federal debt now exceed the entire defence budget. Every time the Fed raises rates to fight inflation it makes that debt more expensive to service. The political pressure to cut rates, or to pressure the Fed into cutting them, is therefore enormous, and it exists completely separately from whatever inflation is actually doing.

When People Learn About the Fed, It Is Already Too Late

New research on how ordinary people form inflation expectations describes something the authors call the cycle of selective inattention. When inflation is low and stable, people simply do not pay attention to monetary policy. They do not know what the Fed's inflation target is and they do not particularly need to. This is entirely rational behaviour. You do not read your home insurance policy until water is pouring through the ceiling.

When inflation surges, people suddenly start paying close attention. They check the news, learn about the central bank, and start tracking price data. The problem is that they are doing this at the exact moment when the central bank appears to be failing. The only lesson they ever absorb is a negative one.

The research finds that current household inflation expectations in the US look almost identical to the trajectory that preceded the 1974 inflation surge. That matters enormously because inflation expectations are self-fulfilling. When people expect higher prices they demand higher wages. Businesses raise prices in anticipation of higher costs. The cycle becomes self-reinforcing. This is precisely what happened in the 1970s and it is precisely what central banks are trying to avoid repeating.

Central Banks Are Losing the Political Battle

Pradhan and Goodhart make a broader argument that should concern anyone who cares about long-term price stability. In any lasting conflict between governments and central banks, they argue, the central banks lose. This is not a partisan observation. It has been true under governments of every political stripe in every country throughout history. When deficits are large and rising and debt is expensive to service, the political pressure to keep interest rates low becomes overwhelming regardless of what inflation is doing.

We are already seeing this play out. The current US administration has offered pointed public feedback to the Fed chair on social media. It has initiated a Justice Department investigation into the central bank's office renovations. It has nominated Kevin Warsh as a potential successor, a man who has publicly called for what he describes as regime change at the Fed, an unusual phrase to deploy when discussing interest rate policy.

It would be a mistake to treat this as a uniquely American problem. The strongest predictors of a central bank losing control of inflation are frequent leadership turnover and being pressured to buy government debt directly. Turkey and Argentina have provided recent and vivid demonstrations of what happens when politicians take full control of monetary policy. Advanced economies have deeper capital markets and stronger institutions. But the underlying mechanics of inflation do not change based on the size of your economy. When a government runs persistent deficits and resists cutting spending or raising taxes, the pressure to quietly print the difference is very difficult to resist indefinitely. It is a slow-motion tax on everyone holding the currency, and unlike an actual tax, nobody has to vote for it.

The Cost of Rebuilding Resilience

There is one more layer to this story that goes beyond central banking. For thirty years the world ran as one giant optimised factory. Things were produced wherever they were cheapest and open sea lanes delivered them everywhere else. That system was extraordinarily efficient. It was also one of the great disinflationary forces of the modern era.

It is now breaking down. The closure of the Strait of Hormuz is the most dramatic demonstration of this, but the underlying shift had been building long before the war started. Countries are discovering they cannot rely on the supply chains and partnerships they took for granted. Canada recently found that almost all of its internet infrastructure runs through the United States. Most countries have similar single points of failure they never thought to worry about when relationships were stable.

The response is to build redundancy. Duplicate supply chains. Onshore critical manufacturing. Build backup energy infrastructure. Increase defence spending. Germany has launched major fiscal expansion to rebuild its military. Poland and the Baltic states are rearming rapidly. All of this is necessary. None of it adds to the productive capacity of the economy. All of it adds to government deficits. Those deficits put more pressure on central banks to keep borrowing costs manageable. Which in turn feeds back into inflation. The cycle is difficult to break once it gets going.

The Age of Cheap Everything Is Over

Pradhan and Goodhart call this the age of the unanchored central banker. Central banks can no longer single-mindedly pursue low and stable inflation, not because they have become less competent, but because the structural conditions that allowed them to succeed have been removed. The demographics have reversed. The trade routes are contested. The deficits are structural. And politicians are increasingly telling central banks what to do.

For thirty years, keeping inflation low was made easier by forces that had nothing to do with monetary policy: a global labour glut, cheap Chinese manufacturing, and an open peaceful trading system underwritten by American naval power. All three of those forces are now weakening simultaneously.

The Strait of Hormuz crisis did not create this problem. It simply made it impossible to ignore any longer. The only people whose inflation expectations remain perfectly anchored at 2% are the members of the Federal Open Market Committee itself.

Everyone else has already noticed that the wind has changed direction.