Top officials from the world’s biggest central banks coalesced around a simple message in Jackson Hole this weekend: They are ready to follow through with higher interest rates, even if it does some damage.
Fed Chair Jerome Powell told the annual gathering of monetary policy makers that the road ahead will “bring some pain to households and businesses” in the U.S., an “unfortunate cost of bringing down inflation.”
Isabel Schnabel, a top European Central Bank official, said she and her colleagues had “little choice” but to continue tightening even if Europe’s economy tips into recession, which is becoming increasingly likely.
Over the two-day conference in Wyoming’s Grand Teton National Park, economists presented research raising more questions than answers, and debated whether new trends triggered by the pandemic would prove temporary or persistent. But there was widespread agreement that, following several decades of work in securing independence from elected officials, now is the time to use it to bring inflation down.
“There is tremendous resolve to do this, and it is actually something that central banks have been preparing for, the last few decades,” said Hyun Song Shin, Head of Research at the Bank for International Settlements in Basel, Switzerland.
“The institutional backing, the economics, the analytical diagnosis — I think it’s all there. And I think we have the institutional setup that is conducive to central banks actually pulling through and getting the job done,” he said during the retreat.
Here are some of the key takeaways from the conference:
Recession risk
Powell — and several other Fed officials who spoke in television interviews Friday on the sidelines of the conference — emphasized that they did not expect to reverse course next year, as investors currently envision. Instead, they said they expect to raise rates and hold them at elevated levels for a time. Schnabel made the same point during the final panel on Saturday.
A “key lesson of the 1970s is that policy makers should also not pause at the first sign of a potential turn in inflationary pressures,” Schnabel said. “Chair Powell alluded to this in his opening remarks. If central banks abandon their fight against inflation prematurely, we risk seeing a much sharper correction down the road.”
Across the board, policy makers gave a “sobering message” about the path ahead, said Julia Coronado, president of MacroPolicy Perspectives LLC, who was also at the conference.
“Even the ECB, which has a much higher chance of recession in the next 12 months than the U.S., knows that the direction of travel is you need to raise rates, and you need to raise rates in a pretty steady fashion,” Coronado said. “There’s a pretty wide range of nuance in the different circumstances countries are facing, and the U.S. is actually probably in the best position going into next year.”
Productivity question
The productivity question dominated the first day of the conference, following the publication of a Commerce Department report on U.S. economic activity the day before.
According to one measure in the report — gross domestic product — the economy contracted by 0.6% in the second quarter on an annualized basis. But another — gross domestic income — suggested the economy grew by 1.4%. The first would imply declining productivity, while the second would imply an increase in productivity.
“Just about every conversation I’ve had since I got to Jackson Hole yesterday has noted that the GDI data for the second quarter, which came out yesterday, was much stronger again than the GDP data,” John Fernald, an economist at the San Francisco Fed who co-wrote the productivity paper, said during his presentation Friday.
Those conversations underscored the uncertainty among policy makers and economists about not only where the economy is headed, but where it is right now. Central bankers may be inclined to see weaker productivity as raising inflation risks, which in turn might eventually push them to raise rates even higher.
“The key, key variable for so much is productivity. That determines the constraints on growth. It determines how much slack there is in the economy, which determines what you need to do for monetary policy,” said Kristin Forbes, a professor at Massachusetts Institute of Technology. “And we just don’t know where it’s going to settle after COVID.”
Balance sheets
A paper on central bank balance sheets presented on Saturday sparked a wave of comments from central bankers in the audience, including Bank of England Governor Andrew Bailey.
The world’s biggest central banks have begun winding down the balance sheets, which they scaled up during the pandemic to relieve pressure on banks and keep long-term interest rates low. The asset purchases created reserves in the banking system, and the unwinds are now extinguishing those reserves.
The question is how much unwinding the central banks will be able to do before they run into potential financial stability issues, and how to adjust if they accidentally go too far.
“There is a very challenging question in a tightening monetary policy world, if we need to intervene for financial stability reasons, because doing central back asset purchases in a world where you are tightening policy is a very difficult message to get across to the outside world,” Bailey said.
Temporary or persistent
The overwhelming consensus among conference attendees was that central banks need to respond aggressively to price pressures as many countries face the highest inflation rates in several decades, though there was less agreement about whether longer-term trends that prevailed prior to the pandemic would eventually reassert themselves.
That sentiment was reflected in Friday’s panel discussion. Jason Furman, an economics professor at Harvard University, argued that central banks should consider eventually raising their inflation targets — which most in developed countries have set at 2% — to avoid imposing unnecessary pain on the economies over which they preside.
In the final minutes of the conference on Saturday, Bank of Japan Governor Haruhiko Kuroda chimed in from the audience with the view from Japan, an outlier in the world economy, with a reminder that the challenge facing policy makers across much of the developed world is not quite universal.
By the end of the year, Japan’s inflation rate “may approach 2 or 3%,” Kuroda said. But in 2023, it will “again decelerate toward 1.5%. So, we have no choice other than continued monetary easing until wages and prices rise in a stable and sustainable manner.”
