Every year, during the last week of August, the focus of the financial world moves to a mid-western mountain resort of Jackson Hole in Wyoming, United States. The resort hosts an annual economics symposium/conference organised by the Federal Reserve Bank of Kansas City. The symposium is unique as one sees participation from economists, and policymakers. The conference started in 1978, and has shaped some of the major ideas on economic research and policy in recent years. The theme of the 2022 conference is ‘Reassessing Constraints on the Economy and Policy’.
The highlight of the conference is its opening remarks, which is always given by the chairperson of the US Federal Reserve. The chair presents the state of the US economy, and also discusses future courses of monetary policy action.
Even this time around, the market participants eagerly awaited the remarks of the Chairperson Jerome Powell, given the US economy is suffering from inflation levels last seen 40 years ago.
In his remarks, Powell reaffirmed the central bank’s commitment to price stability. He said the overarching focus of the central bank ‘is to bring inflation back down to the 2 percent goal’. He drew three policy lessons from the high and volatile inflation of the 1970s and 1980s, and from the low and stable inflation of the past quarter-century.
First, central banks can, and should take responsibility for delivering low and stable inflation. This might sound obvious today, but it was not 50 years ago. The lesson that the main objective of the central bank is to control inflation has been learnt the hard way.
Second, inflation expectations of the future play an important role in setting the path of inflation over time. Powell discussed the concept of rational inattention for explaining the linkage between current inflation, and inflation expectations. Households and businesses pay more attention to persistently high inflation compared to low and stable inflation. So when inflation is high, they incorporate it in their future expectations.
In the 1970s, the inflation remained persistently high. The high inflation drew public attention, which led to the demand for higher wages, and higher prices. This time around, the expectations have been anchored despite high inflation, and attention on inflation. If high inflation persists, these expectations will also become unanchored.
Third, cost of bringing down inflation increases with time. The high inflation of the 1970s and 1980s was a result of multiple failed policies. It was eventually brought down by a lengthy period of very restrictive monetary policy. To avoid similar mistakes, the US Fed will have to ‘keep at it until the job is done’.
The three lessons lead to the conclusion that the US Fed will have to continue to keep interest rates high to fight inflation. Powell said though the current policy will bring pain to households and businesses, ‘a failure to restore price stability would lead to even greater pain’.
Gita Gopinath, First Deputy Managing Director of IMF, echoed similar thoughts in her presentation at the conference. She added that inflation expectations have started to increase, and policies should fight inflation now to avoid pain later.
The symposium was attended by several other policymakers as well. Isabel Schnabel of the European Central Bank asked whether the great moderation phase of macroeconomic stability has given way to the great volatility phase of frequent shocks. Her answer was that the future looked uncertain, and one could see persistence of shocks. However, the central banks’ response to the current shock of high inflation will shape the future course of action, and trust in policy.
François Villeroy De Galhau, the Governor of Banque de France, spoke about the science and art of monetary policy. The science of monetary policy makes it more predictable, whereas the art is more around secrecy, and unpredictability. De Galhau said the science of monetary policy — inflation targeting, central bank independence, etc. — has stood the test of time, but is it time to go back to the art of monetary policy? He argued that we need to bring more science to address new monetary policy challenges.
Chang Yong Rhee, the Governor of the Bank of Korea, reviewed the unconventional monetary policy in emerging markets. These polices were successful in emerging markets during the pandemic when there was surplus global liquidity, but are likely to not be effective during lower global liquidity. He argued that emerging economies should invest in ‘building analytical capacity, strong implementation records, and extensive research’.
Agustín Carstens, the General Manager of the Bank for International Settlements, argued that for a long time policies have focused on demand management. He stressed on the need to bring back supply to the policy discussion, and contribute to increasing growth in productivity.
Nicola Fuchs-Schündeln of Goethe University, Frankfurt, discussed how hours per worker fell, but employment rates increased in the US and European economies. Francesco Bianchi of Johns Hopkins University pointed that government debt rose significantly since the pandemic, which will hinder the achievement of low and stable inflation. Viral Acharya of New York University said that it will be really difficult to restore central bank balance sheets to pre-pandemic levels.
One can't help but compare the 2022 symposium with the one held last year. In 2021, inflation was high as well, but Powell in his opening remarks then said that inflation was transitory, and there was little to worry. The word transitory became part of the lexicon of both the financial media and policymakers. This year the word transitory inflation has changed to persistent inflation, and policymakers have all kinds of worries. The nature, and pace of change in the world economy has surprised one and all.
Schnabel has rightly remarked that we have entered the phase of great volatility. Both the policymakers and public will remember the popular phrase, ‘When the facts change, I change my mind. What do you do?’ We are going to see policymakers follow these words quite often in the near future.
Views are personal and do not represent the stand of this publication.