From The Financial Times, August 27, 2023
Gathering for their annual meeting in the foothills of the Teton Range in Jackson Hole, Wyoming, leading officials and economists traded last year’s angst about inflation and central banks’ credibility for fears that the upheaval caused by the pandemic and the war in Ukraine have ushered in a new era for the global economy.
During the US Federal Reserve’s three-day symposium, current and former policymakers from around the world voiced worries that the well-established economic relationships that underpinned government authorities’ policy decisions were in jeopardy.
They issued an urgent call for a revised playbook to better understand and respond to a rapidly changing landscape that threatened to stoke more frequent supply shocks, higher prices and heightened volatility across financial markets.
Articulating this point most directly was Christine Lagarde, president of the European Central Bank, who spoke at length about the ramifications of tighter labour markets, the transition to a greener economy and the fragmentation of the economy into competing blocs.
“There is no pre-existing playbook for the situation we are facing today — and so our task is to draw up a new one,” she said.
The shift in focus to longer-term structural problems comes amid growing confidence about central banks’ battle against inflation.
“Last year there was this massive trepidation about whether policymakers had gotten things really wrong with inflation and it felt a little bit like a battening down of the hatches, whereas this year I feel like there is more breathing room,” Heather Boushey, who serves on the Biden administration’s Council of Economic Advisers, told the Financial Times.
Policymakers were adamant it was too early to declare victory on inflation, keeping in play the prospect of further interest rate increases. Ben Broadbent, a deputy governor at the Bank of England, said on Saturday that it was “unlikely” inflation would disappear as fast as it had arrived and that interest rates “will probably have to remain in restrictive territory for quite some time yet”.
But signs that it is being tamed have boosted expectations that officials are indeed near or at the end of their historic monetary tightening campaigns.
Still, Lagarde warned that the upheaval of the past three years was likely to bring about persistent price pressures that were more unpredictable and harder to root out.
Other policymakers repeatedly flagged the same risks. On Saturday, Kazuo Ueda, governor of the Bank of Japan, cautioned that in light of mounting geopolitical tensions and tendencies towards “reshoring” — the return of manufacturing activities and jobs to home countries — the global economy could well be “slowly approaching an inflection point beyond which things will change”. While that could lead to local growth booms, it could also result in production inefficiencies, he said.
One growing debate is what these changes might mean for the so-called neutral rate of interest, known as R-star, that neither stimulates nor suppresses growth.
At the US central bank, more officials have nudged up their estimates for R-star, even though the median forecast as of June was unchanged at a pre-pandemic level of 2.5 per cent — or 0.5 per cent in real terms, once adjusted for inflation at 2 per cent. Fed veteran John Roberts, now at Evercore ISI, reckoned the real rate was potentially higher at 0.75 per cent.
Jeremy Stein, a former Fed governor, said he expected R-star to be higher simply because “inflation may stubbornly want to be 3 per cent” versus the Fed’s 2 per cent target, preventing the central bank from any imminent easing.
Others expected population ageing to again act as a depressant once the ongoing inflation crisis passed, though they suggested the debate was far from resolved.
To grasp the magnitude of these structural shifts and their consequences, Boushey — like Lagarde — has called for a rethink of the assumptions governments rely on to make sense of the economic transformations under way and to formulate the right policy responses.
“You don’t have to throw out the old playbook, but you do need new models,” she said, especially those that do not assume major transitions such as the one towards a more climate-friendly system will be “frictionless”.
Pierre-Olivier Gourinchas, chief economist at the IMF, sees benefits in more “disaggregated” models that take into account the fact that shocks — including those associated with Covid-19, Russia’s invasion of Ukraine and the climate transition — are affecting different sectors within and across countries in different ways.
“We need models that can get into that kind of complexity because otherwise we cannot understand why all of a sudden a given shock caused such a huge price increase and in another shock [it did not],” he told the FT.
The IMF’s projections for an extended stretch of slow growth adds renewed urgency to this effort, said Gourinchas. So, too, does a daunting global debt problem that has put advanced and emerging economies on an unsustainable path.
In a widely discussed presentation at Jackson Hole, Barry Eichengreen at the University of California, Berkeley, issued a stark warning about public debts, saying it was politically and financially unfeasible to reduce them no matter how desirable it might be.
Emerging and developing economies are acutely vulnerable, Carmen Reinhart, who previously worked at the World Bank and the IMF, told the FT. Roughly 60 per cent of the poorest countries are already in or close to debt distress, a particular concern in a “shock-prone, fragmented environment”.
“It can become self-perpetuating,” she said. “With weaker initial conditions, if you get hit by a shock, you don’t have the ability to respond very much and therefore you have a weaker recovery.”
Even if he was not concerned about debt dynamics in the US or in most European countries right now, Gourinchas said he was worried about this capacity issue on a wider scale in the event of another large shock that would require governments to inject 10-20 per cent of gross domestic product in fiscal support.
“I don’t think they can do it again,” he said. “We don’t have an insurance policy anymore. We are at the edge.”
Prof George Alogoskoufis 