ARE CENTRAL BANKS BETRAYING THEIR MANDATES? / PROJECT SYNDICATE

Are Central Banks Betraying Their Mandates?

With inflation still above target and labor markets tight, central banks in the United States, the United Kingdom, Europe, and Japan have little reason to cut interest rates. Premature monetary easing would mean shirking their duty to safeguard price stability precisely when discipline is essential.

Willem H. Buiter

RALEIGH – On August 6, five of the nine members of the Bank of England’s Monetary Policy Committee (MPC) voted to cut interest rates by 25 basis points, to 4%, while one member favored a 50-basis-point cut. 

This suggests they either disregarded the BOE’s mandate to keep inflation at or below 2% or assumed that the current surge in prices will be short-lived.

Other major central banks have made similar missteps. 

The European Central Bank (ECB) and the Bank of Japan (BOJ), for example, maintain policy rates that are too low, while the US Federal Reserve – under growing pressure from President Donald Trump – appears poised to cut rates prematurely.

The problem is especially acute in the United Kingdom, where inflation remains above target and continues to rise. 

Annual consumer-price-index inflation rose from 3.4% in May to 3.6% in June, its highest level since January 2024. 

Core CPI rose from 3.5% to 3.7%, while the one-month rate was 0.3%. 

The CPIH – which includes owner-occupiers’ housing costs and is, in my view, a better indicator – reached a 17-month high of 4.1% in June, and core CPIH edged up from 4.2% to 4.3%.

Wage pressures, while easing slightly, remain significant. 

Annual growth in employees’ average earnings was 5.2% for regular pay and 5.3% for total pay (including bonuses) in June. 

Average weekly earnings, including bonuses, rose by 5% over the three months ending in May, down from 5.4% in the previous three-month period.

Notably, UK inflation has not been driven by currency movements. 

Sterling’s effective nominal exchange-rate index remained virtually unchanged, slipping from 85.9 in January to 85.7 in May.

Taken together, these indicators suggest that the real economy is not weak enough to achieve a speedy return to 2% inflation while simultaneously cutting interest rates. 

Unemployment has increased only modestly from its post-COVID low of 3.6% (the lowest rate in 50 years), rising from 4.4% in December-February to 4.7% in March-May. 

Between April and June, the employment rate rose to 75.3%, while the economic inactivity rate – the proportion of working-age individuals who are neither employed nor actively seeking employment – declined from 21.3% in December to 20.8% in May. 

Together with the steady growth in real wages, despite the UK’s dismal labor-productivity growth since the 2008-09 financial crisis, these trends suggest that demand in the labor market remains strong.

Even with tight labor markets, growth remains sluggish, constrained by weak labor-force expansion – though the data are of poor quality – along with reduced private and public investment and very slow total-factor productivity growth. 

Real GDP grew by 0.7% in the first quarter of 2025; however, monthly estimates show declines of 0.1% in May and April. 

Over the three months ending in May, real GDP is estimated to have grown by 0.5% from the three-month period ending in February.

Against this backdrop, the BOE’s policy rate is clearly well above any reasonable estimate of the “neutral” rate – the policy rate equal to target inflation plus the “neutral” real interest rate (the real interest rate consistent with full employment and on-target inflation). 

The neutral policy rate neither spurs nor slows the economy. 

MPC member Alan Taylor’s point estimate of the UK’s real neutral rate is 0.75%, implying a neutral Bank Rate of 2.75%. 

At 1.25 percentage points above that, the BOE’s current policy is restrictive – but not restrictive enough. 

With core CPIH inflation at 4.3%, the sensible move would have been to raise rates, not cut them.

Turning Away from Price Stability

The different mandates of major central banks should help explain their recent policy decisions. 

Unlike the Fed, the BOE’s monetary-policy objectives are not symmetric. 

The Fed’s statutory goals are to promote “maximum employment, stable prices, and moderate long-term interest rates.” 

For reasons that remain unclear, the Fed rarely mentions the third objective in its communications, focusing instead on its so-called dual mandate of maximum employment and price stability. 

This approach assumes that meeting the first two goals will automatically deliver the third – a proposition that has never been formally tested, let alone proven.

By contrast, the BOE’s mandate is explicitly hierarchical. Under the Bank of England Act, its monetary-policy objectives are, first and foremost, to maintain price stability, and “subject to that, to support the economic policy of His Majesty’s Government, including its objectives for growth and employment.”

The ECB mandate follows the same logic. 

Article 127.1 of the Treaty on the Functioning of the European Union states: “The primary objective of the European System of Central Banks … shall be to maintain price stability. 

Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union…”

Eurozone inflation is projected to remain at 2% in July, with core inflation unchanged at 2.3%. 

Unemployment was 6.2% in June – a historic low, though significantly higher than in the United States, Japan, and the UK. 

With inflation at or slightly above target and unemployment at or below the natural rate, one would expect the ECB’s deposit rate to be at least neutral.

Instead, at 2%, the rate is still below that threshold. 

Pre-pandemic estimates often put the eurozone’s neutral real interest rate at zero or slightly negative, and recent ECB staff calculations range from -0.5% to 0.5%. 

Meanwhile, estimates relying on the Holston-Laubach-Williams model, based on somewhat earlier data, range from -0.5% to 1%.

Given that both public and private investment, driven by AI adoption and increased defense spending, are likely to outpace savings in the coming years, a more plausible range for the neutral real rate is 0.5% to 1%. 

This implies a neutral nominal rate of 2.5% to 3%, meaning the current 2% rate remains expansionary. 

Moving toward neutral or slightly restrictive policy would require raising rates closer to that range.

The BOJ faces a similar imbalance between its mandate and its policy stance. 

Like the ECB, its primary objective is price stability. 

According to the Bank of Japan Act, monetary policy should be “aimed at achieving price stability, thereby contributing to the sound development of the national economy.”

Japan’s annual CPI inflation excluding fresh food reached 3.5% in the second quarter of 2025, up from 3.1% in the first quarter and well above the BOJ’s 2% target.

Core CPI inflation climbed from 2.7% to 3.2% over the same period. 

Unemployment has stayed at 2.5% since October 2024 – exceptionally low by both historical and international standards. 

While real GDP growth remains slow and uneven, it is not, on average, below most estimates of potential growth.

Yet the BOJ’s policy rate – the uncollateralized overnight call rate – is just 0.5%. 

In October, BOJ economists put Japan’s neutral real interest rate between -1% and 0.5%. 

Even if those low figures are accurate, they imply a neutral nominal rate of 1% to 2.5%. 

In other words, BOJ policy remains expansionary, as in the eurozone, despite Japan’s inflation materially exceeding its target.

Does Japan’s towering public debt create an argument for keeping the policy rate low? 

In its latest World Economic Outlook, the International Monetary Fund estimates Japan’s gross debt-to-GDP ratio at 234.9%. 

While higher interest rates would undoubtedly raise the cost of servicing that debt, real interest rates on Japanese government bonds remain deeply negative. 

Consequently, fiscal sustainability should be restored through higher taxes, lower public spending, or debt restructuring – not by undermining the BOJ’s price-stability mandate.

The Case Against Cutting Rates

The Fed is the only one of the four central banks with a true dual mandate, giving equal weight to stable prices and maximum employment. 

In the US, annual CPI inflation rose by 2.7% in July, while annual core CPI increased by 3.1%. 

Unemployment ticked up from 4.1% to 4.2% in July – still low by historical standards and likely close to the natural rate, though higher than the post-COVID low of 3.4%.

Other indicators, such as employment and real GDP growth, reveal a mixed picture, but there is no sign of a meaningful slowdown. 

Recent estimates of the neutral real interest rate range from 0.78% to 1.37%. 

The Fed’s own projection of 1% implies a neutral nominal rate of roughly 3%.

Given this, the current target range for the federal funds rate, between 4.25% and 4.5%, is firmly in restrictive territory – a stance justified by above-target inflation and historically low unemployment. 

Unless the economy is on the brink of a sharp slowdown or tariff-induced inflationary pressures suddenly subside, there is no case for the Fed to cut rates in September.

Like all central banks, the BOE has a mandate to “protect and enhance” the stability of the UK’s financial system. 

While this responsibility rests primarily with the Financial Policy Committee, the MPC can intervene in times of crisis through rate cuts, asset purchases, and adjustments to lending terms.

During the 2008-09 crisis – the worst financial shock since the 1930s – the need to restore stability provided a clear rationale for rate cuts. 

UK unemployment climbed from 5.2% in late 2007 to 7.9% by mid-2009, peaking at 8.5% in late 2011. 

That level of labor-market slack was enough to drive inflation down toward the BOE’s primary target, even with interest rates at historic lows.

There is no comparable financial-stability case for rate cuts in the UK today, and the same holds for the US, the eurozone, and Japan (the ECB and the BOJ, both well behind the curve, should be raising their policy rates). 

If the BOE’s objectives gave equal weight to price stability and to growth and employment, keeping rates steady might be justified. 

But with price stability as its primary mandate, a 25-basis-point increase would have been the more appropriate course.

The main risk to the economic outlook and to my policy rate recommendations is a sharp and sudden global slowdown – a possibility that cannot be dismissed as Trump’s trade war continues to escalate. 

An economic downturn in the eurozone, the UK, and Japan that drives inflation below target could justify rate cuts, even where price stability is the central bank’s primary mandate.

The US, for its part, faces a more complicated trade-off if the tariff wars deepen. 

In addition to slower growth, it would face the prospect of higher inflation, fueled by tariff hikes and possibly by the dollar’s further depreciation. 

The Fed’s dual mandate gives it the flexibility to cut rates to stimulate employment, even if that means tolerating a short-lived, tariff-driven surge in prices. 

But the ability to act should not be mistaken for the need to act, given that moving too soon could cost the Fed its hard-won credibility.

Willem H. Buiter, a former chief economist at Citibank and former member of the Monetary Policy Committee of the Bank of England, is an independent economic adviser.