Source of this article: World knowledge
Author of this article: Ma Wei, Assistant Researcher at the American Institute of the Chinese Academy of Social Sciences
Since 1978, on the third weekend of August every year, the US Federal Reserve Bank of Kansas will hold seminars in Jackson Hole, a famous resort town in Wyoming. Central banks, including the Chairman of the Federal Reserve, and fiscal officials, scholars and financial market participants, will be invited to participate to discuss important issues facing the US and the world economy. At previous annual meetings, central bank officials in major developed economies will send new monetary policy signals, either change direction or take new actions. Therefore, the Jackson Hall Conference is also regarded as a "barometer" of global monetary policy trends.
The theme of this year's Jackson Hall meeting was "Reassessing Constraints on the Economy and Policy". Several central bank officials, including Federal Reserve Chairman Powell, ECB Executive Committee member Schnabel, General Manager of (BIS), and the head of international financial organization , attended and delivered speeches.
On July 27, 2022, Federal Reserve Chairman Powell attended a press conference in Washington, announcing a 75 basis point rate hike, reaching the range of 2.25% to 2.5%.
Fighting inflation: The core topic of this conference
Unlike the previous two years of discussion on the structural issues of the US economy, Powell's slightly brief speech this year focused on inflation , the most important challenge facing the US economy and the Federal Reserve, which is also the most important topic discussed by other guests at this session. Powell changed his previous speech style as the chairman of the Federal Reserve and clarified the next trend of monetary policy: the Federal Reserve will regard fighting inflation as its main policy goal and continue to tighten monetary policy until inflation returns to its target level; even if the US economy falls into recession afterwards, it will not change the Federal Reserve's determination.
Powell first made a clear point of view: Although reducing inflation may lead to short-term economic recession and rising unemployment, these costs are not much greater than the out-of-control inflation. The current US economy is obviously overheating, and inflation levels have dropped slightly - the consumer price index (CPI) fell from 9.1% in June to 8.5% in July, but the overall trend of high inflation has not changed. The Federal Reserve will maintain the tight monetary policy for a long time in the future. Powell also summarized three lessons learned in the fight against high inflation in the 1980s: First, the central bank should and can assume the responsibility of stabilizing inflation. Although high inflation in the 1980s was affected by supply-side factors such as oil price shock, the Federal Reserve finally relied on continuous interest rate hikes to suppress total demand before controlling inflation. Similarly, although the current inflation in the United States is affected by factors such as high global inflation and poor supply chains, the Federal Reserve can still achieve a supply-demand balance by reducing total demand, thereby reducing inflation. Second, public inflation expectations will affect the actual inflation trend. If inflation continues to remain low, the public will "rationally ignore" inflation, that is, households and businesses will not consider price changes at all when making economic decisions. And the higher the inflation, the more the public expects it to stay high and incorporate that belief into salary and pricing decisions. The United States is increasingly facing the risk of out-of-control inflation expectations. Third, the Fed must continue to raise interest rates until inflation is controlled. The longer inflation lasts, the more deeply rooted its role in wages and price making, and the greater the cost of economic recession and unemployment caused by inflation. Therefore, the Fed must be determined to continue hike interest rates.
Powell's speech was a correction and review of previous continuous misjudgments, and was also intended to reverse the current market misunderstanding. Since the second quarter of 2021, Powell first insisted that inflation is only "temporary" and has not started the tightening process for a long time. Later, he repeatedly emphasized that the Federal Reserve is powerless to do anything about inflation caused by poor supply chains. After the interest rate hike started in March this year, Powell tried to dispel the market's fear of economic recession and strive to achieve an "soft landing" of the economy.It can be said that the Fed's misjudgment on inflation and poor market communication have gradually eroded the market's confidence in the Fed's control of inflation, causing inflation to continue to rise after interest rates. It can be said that Powell's firm and clear anti-inflation declaration at this meeting is a clear signal that the Federal Reserve should have long been sent to the outside world. After the Federal Reserve raised interest rates by 225 basis points four times since March, the market began to shift from "inflation trading" to "recession trading" some time ago, betting that the Federal Reserve will gradually cut interest rates after the economy fell into recession in 2023. After hitting a high of 3.5%, the 10-year Treasury bond yield once fell to 2.6%, and US stocks also rebounded sharply. After Powell's speech, the yield on the 10-year Treasury bond rose to 3.3% again, and the US stock market also fell sharply. The market finally received a signal that the Federal Reserve resolutely resisted inflation.
data released by the UK's National Office for Statistics showed that the UK's inflation rate rose from 9.4% in June to 10.1%, reaching the highest level since February 1982. The picture shows the Bank of England Building, London, UK on August 17, 2022.
Supply shock: a long-ignored source of inflation
ECB Executive Committee member Schnabel and general manager of the Bank for International Settlements Carstens also focused on inflation, but emphasized more about the impact of changes in supply factors on inflation. They all said that stable supply is an important factor in ensuring low global inflation since 1980. However, since the epidemic and the Ukrainian crisis escalated, the supply side of the global economy has suffered a major impact, which constitutes the main cause of high inflation, and is likely not to change in the short term. The focus of monetary policy should be on controlling inflation.
Schnabel believes that the global economy may be experiencing a turning point from "big easing" to "big fluctuations". Since 1980, thanks to good monetary policy, the global economy has entered a period of "big easing" with significant decline in inflation and output volatility, and the supply impact was less during this period. In recent years, the global economy has begun to face supply-side adverse impacts such as climate change, globalization decline caused by the epidemic and geopolitical conflicts, instability in energy supply (mainly Europe), and may move from "big easing" to "big fluctuations", posing major challenges to the monetary policies of central banks in various countries. The central bank's future monetary policy can no longer "act cautiously" between controlling inflation and maintaining growth, but must put controlling inflation first. There are three main reasons: First, the duration of inflation is uncertain. Central banks should assume that inflation persists when implementing policies, because underestimating the duration of inflation is much greater than overestimating. Second, the risk of out-of-control inflation expectations is rising. Eurozone consumers' medium-term inflation expectations have risen to 5%, which is both the result of monetary policy's slow response to current high inflation, and also reflects that the monetary policy framework has focused more on systemic biases in recent years than on too high inflation. Third, the central bank's slow action is very expensive. The flat " Phillips curve " (Note: This curve is used to describe the relationship between employment and inflation. In the past 20 years, especially since the international financial crisis, this curve has become flattened, that is, the inflation level corresponding to the decline in unemployment has become lower) means that the central bank will not cause a rapid rise in inflation when stimulating the economy, and it also means that once inflation becomes deeply rooted, a significant contraction may be required to reduce inflation.
Carstens said that signs of fragility in supply have long been ignored, and the global total supply of the economy is undergoing a transition from "twind" to "frontwind". In the past 30 years, factors such as relatively stable political environment, technological progress, globalization and favorable population trends have enabled the total supply to respond quickly to changes in total demand, and inflation has stabilized at low levels for a long time. Correspondingly, monetary policy needs to be tightened to a lower degree than in the past when the economy expands; central banks can provide strong stimulus and believe that inflation will always be under control. Because both nominal and real interest rates fell to low or even negative values, fiscal policy has also increased its efforts. In other words, the sustained economic growth is increasingly appealing to the aggregate demand stimulus provided by fiscal and monetary policies.But at present, the epidemic has exposed the vulnerability of global supply chains; the Ukrainian crisis has disrupted the commodity market, threatened energy and food security, and accelerated the realignment of geopolitical alliances, threatening the future of globalization; the aging of the population has intensified, and the epidemic will have a lasting impact on the quantity and quality of workers. These all mean that adverse impacts on the supply side may continue in the long run, and continuing to rely on aggregate demand tools to promote growth will lead to higher and more difficult to control inflation. In this case, central banks cannot expect to smooth out all economic volatility, but must first focus on maintaining low and stable inflation.
It can be said that the important role of in the supply side of has been ignored in the past. Countries have become accustomed to managing the economy from the demand side, and the politically popular " Keynesian " policy is popular. In recent years, the academic community also proposed the "sacred coincidence" of monetary policy to prove such a policy orientation, that is, when the central bank maintains inflation to a moderate level, it can automatically achieve stability in output and employment, and when there are more and more adverse impacts on the supply side, this "sacred coincidence" is broken. The central bank's attempt to tame economic cycle is not always successful, but instead gradually accumulates negative impacts. Just as after the global economy stagflation in the 1980s, the academic community began to reflect on "Keynesianism", and now it seems that it is time to reflect on it again. When the supply shock comes, monetary policy is not omnipotent. Even when facing the risk of recession, inflation control must be regarded as the primary goal.
Monetary Policy: Effective but non-all-round
At the meeting, some scholars believed that a continuous tightening monetary policy cannot completely curb this round of high inflation, and responsible fiscal policies must be required to cooperate.
Johns Hopkins University scholars and Chicago Fed experts submitted to the conference believe that whether the current inflation can subside depends on the credibility of the fiscal authorities in stabilizing serious fiscal imbalances. If residents expect that the government will continue to implement radical fiscal policies in the future, the fiscal deficit will continue to expand and the level of sovereign debt will continue to rise. Then, residents will inevitably expect higher inflation, because only higher future inflation can "eliminate" the government's nominal debt and balance the government's cross-term budget. This is called "the fiscal theory of price levels." A simulation operation of the Biden administration's $1.9 trillion "American Relief Program" found that fiscal expansion contributes about half of the contribution to inflation, and the other half is cost-driven. But cost-pushing inflation is often one-time, and inflation from fiscal expansion may change the medium- and long-term inflation center. Short-term inflation can be controlled through tighter monetary policy, while trendy, medium- and long-term inflation will be higher. If the central bank raises a sharp interest rate, the government debt ratio will rise further, which will make residents more convinced that inflation will be higher in the future. Therefore, to overcome inflation in the post-epidemic era, not only does global central banks need to maintain a hawkish stance, but also requires countries, especially the US government, to carry out comprehensive reforms to the fiscal framework. It also requires consistent monetary and fiscal policies to provide a clear path for target inflation and debt sustainability. The theme of the Jackson Hall conference is "Reassessment of Economic and Policy Constraints", which refers to "uniforming high inflation." The global low inflation over the past 30 years seems to have made central banks in developed economies forget the risk of inflation returning. This meeting is a warning: in the era of high inflation, if monetary policy does not regard fighting inflation as its top priority, it will neither restrict inflation nor maintain economic growth and employment stability. Therefore, both the Federal Reserve and the European Central Bank have made it clear that they will implement austerity monetary policy without hesitation for some time to come. From this point of view, this round of high inflation is expected to be gradually controlled, but we must be prepared for the US and European economies to fall into a short-term recession. It is worth noting that the Bank of Japan is still adhering to the loose monetary policy of . Even if the yen exchange rate has fallen to a 30-year low, a long-term weak economy and still low inflationary pressure may be the main reasons.Bank of Japan officials did not attend the Jackson Hall meeting, and there was no way to see its possible policy changes in the future.
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