Monetary policy in a changed world

Under the title of ‘Structural shifts in the global economy’, the annual Jackson Hole meetings hosted by the Federal Reserve Bank of Kansas City last weekend gave a sense of the challenges of the emerging global economic and political context for monetary policy. 

The last Jackson Hole meetings have been focused on inflation and monetary policy issues.  But as inflation begins to reduce, there is a broader focus on the environment in which monetary policy will operate.

There was little that was market-moving; Fed Governor Powell’s remarks did not surprise and ECB President Lagarde’s speech (on which more below) focused on structural issues rather than near-term inflation dynamics in Europe.  Inflation is higher than target, and central bankers across advanced economies remain focused on reducing it.  As a reminder of this challenge, data released on Thursday reported that Eurozone inflation to August came in above expectations at 5.3%.

But there was much that was instructive on the agenda.  I took three things from the papers and remarks. 

1. Increasing economic turbulence

First, there is deep uncertainty about how the economy is behaving since the pandemic.  New regularities in economic relationships are emerging. 

Mr Powell described the decision-making process in central banks as ‘navigating by the stars under cloudy skies’: identifying r* in this new world is very difficult as a practical matter.  And Ms Lagarde noted that ‘There is no pre-existing playbook for the situation we are facing today — and so our task is to draw up a new one’.  

This uncertainty in the central bank community is partly because of the materiality and novelty of the shocks (the pandemic) but also because they are largely supply-side shocks – from disruptions to global supply chains to constrained labour force participation.  And these are coinciding with a series of structural shifts in the global economy.  Ms Lagarde’s very good speech identified a range of structural shifts in the global economy to which monetary policy would need to adjust.

These included: ‘profound changes in labour markets and the nature of work’, which have been accelerated by the pandemic; the energy transition and climate change; and ‘deepening geopolitical divide and a global economy that is fragmenting into competing blocs’, with accompanying trade and investment restrictions on cross-border flows.  In addition to their direct economic impact, these shifts will reshape inflation dynamics.

The full note is available at: https://davidskilling.substack.com/p/monetary-policy-in-a-changed-world