Central banks are suffering a major headache … and only an exit from QE will solve it

Big Headache

The death of a major economic concept is riling many economists and analysts.

Known as the Phillips Curve, a concept developed by New Zealand economist William Phillips, it shows that inflation and unemployment have a stable and inverse relationship and is a fundamental philosophy for many.

In recent months with central banks using artificial ways to pump money into the economy, this inverse relationship is seen to be dying, or rather "flattening" as many economists point out.

Low wages and temporary jobs add pressure on workers. That in turn leads to less spending power in the economy even though the level of unemployment maybe falling.

This is not great news for central bank policymakers across the world pumping artificial money into the system to bring the global economy back to its pre-2008 crisis days.

Ever since the global financial crisis, central banks have pegged their monetary policy on these two pillars – inflation and unemployment.

While they have been successful in trying to bring the level of unemployment down, inflation hasn't edged up to the target many of the central banks had set earlier.

Recent economic data across the U.S. and Europe have shown that while unemployment seems to be cooling down, inflation is lagging gains.

As a result, institutions like the European Central Bank (ECB) have had to lower their inflation target recently.

The ECB, in its Governing Council meeting in July, discussed at length the disconnect between inflation and employment in the euro zone economy, attributing it to a number of structural factors such as changes in labor markets, work contracts and wage-setting processes.

But policymakers have still not been able to find a solution out of this deadlock. The answer lies not in lowering targets but slowly removing their foot off the accelerator.

Perhaps it is time for central banks to gracefully exit the long and arduous process of quantitative easing before the scars it leaves behind are too tough to handle.

Alberto Gallo, head of macro strategies and manager of the Algebris Macro Credit Fund, told CNBC last month that central banks should look at removing artificial stimulus for three reasons – it is becoming less useful, has side-effects and to build an adequate policy buffer to deal with future risks.

Central banks, however, have always been very vague when communicating, especially when addressing questions like the dying Phillips Curve.

One would expect that policymakers at the Jackson Hole Symposium in Wyoming last month exchanged notes in order to coordinate their timely exit.

But will we ever know? Or is it the waiting game all over again?

—Spriha Srivastava is lead blog writer on World Markets Live , CNBC's daily market blog. You can follow Spriha on @spriha

For more insight from CNBC contributors, follow @CNBCopinion on Twitter.

JefferiesAnd the Best Place to Work in the global financial markets 2017 is...

Register for Financial Markets News Alerts