Top multilateral officials and monetary policymakers have warned that central bankers face a more challenging economic landscape than they have faced in decades and will find it difficult to root out high inflation.
The world’s leading economic authorities this weekend sounded the workforce alarm against the Federal Reserve. European Central Bank and other central banks as they grapple with the worst inflation in decades. Speaking at the annual meeting of central bankers in Jackson Hole, Wyoming, many said the global economy is entering a new, tougher era.
“At least for the next five years, monetary policy-making will be more difficult than it was in the two decades prior to the outbreak of the pandemic,” Gita Gopinath, deputy managing director of the International Monetary Fund, told the Financial Times.
“We are in an environment where supply shocks will be more volatile than we are used to, and that will lead to more costly trade-offs for monetary policy,” she said.
The pace of price growth skyrocketed as supply chain disruptions from Covid-19 shutdowns collided with rising consumer demand fueled by fiscal and monetary support unprecedented since the start of the pandemic. The all-out Russian invasion of Ukraine triggered a series of commodity shocks that created further supply restrictions and increased prices.
These dynamics have forced central banks to tighten monetary policy aggressively to ensure that inflation does not become deeply entrenched in the global economy. But given its limited ability to address supply issues, many fear that they will have to endure more economic suffering than in the past in order to restore price stability.
David Malpass, President of the World Bank, warned that central bank tools, especially in advanced economies, are ill-suited to address the supply-related inflationary pressures driving a large part of the recent inflation rally.
“The price increase has to compete with a lot of friction within the economy, so I think that’s their biggest challenge,” he said. “You raise rates in the hope of curbing inflation, but it is counteracted by a lot of friction within the supply chain and the production cycle.”
Key figures at both the Federal Reserve and the European Central Bank made it ‘unconditional’ pledges to restore price stability. Jay Powell, Chairman of the Federal Reserve, on Friday warned It is the result of a “sustainable period” of slow growth and a weak labor market.
Gopinath cautioned that the ECB faces particularly steep swaps. She said there was a “real risk” of an inflationary environment accompanied by stagnant growth and high inflation in Europe, given the severity of the energy crisis caused by the Ukraine war.
Malpass said developing economies are particularly vulnerable as global financial conditions tighten.
“Part of that is higher interest rates and they have a lot of outstanding debt, which increases their debt servicing costs, but makes it more difficult for them to get new debt,” he said. “An additional challenge is that advanced economies are highly dependent on global capital and energy resources, creating a shortage of working capital for new investments. [elsewhere]. “
The enormity of the economic challenge facing central banks was summed up by Changyong Rhee, president of the Bank of Korea, when he said that whether the world would return to a low inflation environment was “the billion dollar question”.
Traversing the booming atmosphere among Jackson Hole attendees—who, due to the pandemic, had waited two years for socializing and face-to-face exchange of ideas—was the overarching concern that the world and the economic relationships underpinning it had changed radically.
The sharp shift in economic dynamics caused attendees to do some soul-searching. “There is a lot of humility in the room [about] “What we know and what we don’t know,” Gopinath said.
The event revealed in stark detail the fault lines caused by the pandemic and Russia’s invasion of Ukraine.
“We have an energy crisis, a food crisis, a supply chain crisis and we have war, all of which have profound implications for the economic performance of the world, the nature in which the world is more interconnected and more interconnected,” said Jacob Frenkel, the former governor of the Bank of Israel who chairs the G30 board, an independent consortium of Former Policymakers: “Most importantly, for the relative prices of many, many things.”
Matters are complicating uncertainty about how much policy tightening is needed in the face of unexpected fluctuations in supply, and thus prices.
“At the moment, we have to make our decisions with high uncertainty,” said Thomas Jordan, president of the Swiss National Bank. “Interpreting current data is challenging, and it is difficult to distinguish between temporary and persistent inflationary pressure.”
According to Schnabel of the European Central Bank, the next few years are at risk of being known as “great volatility” – in contrast to the past two decades, which economists have called the “Great Moderation” due to the relatively calm dynamics.
Many officials have come to believe that the structural forces that have kept price pressures in check – chiefly globalization and labor oversupply – have been reversed.
Agustín Carstens, Managing Director at the Bank for International Settlements, warned that “the global economy appears to be on the cusp of a historic change as many of the aggregate supply tailwinds that have kept the lid on inflation appear to be turning into headwinds”. “If this is the case, the recent recovery in inflationary pressures may be more steady.”
Skeptics of this view say they are confident that the world’s leading central banks will be able to fend off entrenched high inflation.
“The issue that central banks need to focus on is not creating inflation credibility,” said Adam Posen, president of the Peterson Institute for International Economics. “The problem is to reformulate strategy and inflation targets for a world in which you will face more frequent and larger negative supply shocks.”
The 2 percent inflation target, which central banks in advanced economies have mostly adhered to for decades, was brought up repeatedly during the conference, with economists suggesting it may need to adjust to a more divided global economy.
Long before inflation spiked, the Fed announced in 2020 that it would target inflation at an average of 2 percent over time, in order to offset previous periods that missed the target. Last year, the European Central Bank said it would tolerate inflation temporarily rising above 2 percent at times.
Many economists have called for a 3 percent inflation target. According to Stephanie Aronson, a former Federal Reserve employee now at the Brookings Institution, this will give central banks more flexibility to look beyond supply shocks and support the economy during recessions.
“If you go down to 2 per cent and you can shorten the amount of low growth you need and also move to a better system in the long run, because you are less constrained by the zero threshold, it seems to me that the former chief economist at the International Monetary Fund, Maurice Obstfeld, said in an interview: It’s a win-win for both parties.”
When and how a central bank like the Federal Reserve and other central banks deal with changes to their mandates will be critical, given their poor control over inflation and the risks that may take root in households and businesses’ expectations about future price increases.
Karen Dinan, a Harvard economics professor who previously worked for the US central bank, said it would be “extremely dangerous” for the Fed and its peers to even bring up the issue until they got inflation under control.
“They need to do everything they can to maintain their credibility – and perhaps in some cases, restore their credibility – but they will have to think seriously about what this new target should be.”
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