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‘The playbook is quite unusual…’: central bankers cautious on global economic prospects

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How robust is the global economy’s recovery? What confidence should we have that economies are bouncing back after (hopefully) the worst of the pandemic? What’s keeping central bankers awake at night?

European Central Bank (ECB) president Christine Lagarde, US Federal Reserve chair Jerome Powell, Bank of England governor Andrew Bailey and Bank of Japan governor Haruhiko Kuroda came together (virtually) on 29 September to answer these questions in an hour-long discussion on global economic prospects entitled ‘Beyond the pandemic: the future of monetary policy’ during the ECB Forum on Central Banking

This was (literally) Lagarde’s show – she was on home turf in Frankfurt, seated alongside the panel’s moderator, Reuters editor-in-chief Alessandra Galloni, with her three fellow leading central bankers beamed in digitally.

The ECB president had already delivered the forum’s introductory address on ‘Monetary policy during an atypical recovery’ and opened her remarks by reiterating the previous day’s main message. “The economy is back from the brink, but not completely out of the woods,” she said, assessing the euro area’s part-recovery after more than 18 months of Covid-caused disruption.

We have seen a very unusual recession followed by a very unusual recovery and we are in that process of recovery,” Lagarde told Galloni and the online audience. “It is the steepest recovery we have seen in the euro area since 1975. By the end of 2021 the euro area will be back to pre-pandemic [output] level, and will move back to the trend that it was on before the pandemic hit us.”

The recovery is “very unusual, very rapid,” she said, with the economic rebound spurred on by the vaccination rollout and removal of most lockdown measures.

But, clearly, this is an uneasy period. “We still have uncertainty and those uncertainties operate as a threat to the growth that we are seeing in the really unusual recovery,” Lagarde said, citing three principal concerns: supply-side bottlenecks and the disruption of supply-chains (“that seems to be in some sectors accelerating, for example, in shipping and cargo-handling”); soaring energy prices; and, of course, “potential new waves of the pandemic that would be vaccine resistant and that would lead government and policymakers to go back to containment and lockdown measures.”

Who knows what’s next? It’s not an easy period for central bankers – and this session wasn’t a bed of roses for either Bailey or Powell.

Brexit seems to have made any British representative in global fora something of a curiosity: like a previously sensible child who has taken himself to the barbers and demanded a radical hair-cut that he knows his family won’t like. Everyone at the dinner-table doesn’t quite know what to say.

Teased by Galloni that he had “made it” to the discussion “despite all the queues at the petrol pumps in the UK”, Bailey described the UK’s recovery as “uneven.” Galloni, who herself is normally based in London, knew the global audience was likely intrigued by recent media coverage of the UK’s fuel shortages and empty supermarket shelves. Are the UK’s apparent struggles caused by Covid? Brexit?

Monetary policy can’t solve supply-side shocks,” Bailey pointed out, saying there was no “common cause”. “We [the BoE] have to focus on the potential second-round effects from those shortages.”

It has not been the easiest week for Powell, who has been Fed chair since 2018 (his term expires in February next year).

Speaking before the Senate banking committee earlier this week, Massachusetts senator Elizabeth Warren accused the Fed of watering down post-financial crisis bank regulations and weakening the US banking system. She described Powell’s record as giving her “grave concerns,” adding that “over and over, you [Powell] have acted to make our banking system less safe, and that makes you a dangerous man to head up the Fed.”

Powell declined to comment on that but was characteristically lucid on the current challenges faced by the Fed. In short, the economic outlook “while quite positive in the medium term is highly uncertain,” he said.

It’s frustrating to acknowledge that getting people vaccinated and getting [the] ‘Delta’ [variant] under control still remains the most important economic policy that we have,” Powell said. “And it’s also frustrating to see the bottlenecks and supply-chain problems not getting better and, in fact, at the margin apparently getting a little bit worse.”

The Covid-caused downturn is obviously unusual – as is the bounceback. “Usually the services sector would be OK in a downturn and goods would be sharply cyclical. We have the opposite. So, the playbook for how to think about this is quite unusual,” Powell observed.

US fiscal policy had “more than replaced lost incomes” during the pandemic, he said, with “quite strong demand” across the economy. But supply-side constraints are “really holding back the economy.”

But ultimately the outlook for next year is quite a strong year with growth well above trend and unemployment reaching significantly lower levels than now,” said Powell.

Then there’s inflation, which reached 4.2 per cent in the US in July, and is troubling policymakers everywhere. “Inflation is running well above target and we expect it will continue to do so in the coming months before moderating as bottlenecks ease,” he said.

The central bankers were asked how long price rises may be sustained. “For some time we, and others, have been forecasting that the current inflation spike will not lead to a new inflation regime in which inflation remains high year after year,” said Powell. “The current spike is really a consequence of supply constraints meeting very strong demand – that is all associated with the re-opening of the economy, which is a process that will have a beginning, middle and end.”

The view from Frankfurt for the euro area was the same. “I agree with Jay Powell in considering that the price increase that we are seeing is largely attributable to the re-opening of the economy,” said Lagarde. “We have no reason to see the price increases we are seeing now will not be largely transitory.”

The uncertainties don’t make it an easy time to be authoring forward guidance.

What about Asia? There was brief discussion of China’s property bubble but the focus was on Kuroda’s home country.

The economy has picked up “gradually” after contracting by about 10 per cent, the Bank of Japan’s long-serving governor said, adding that it could return to pre-pandemic levels by the end of the year or early in 2022. But the country’s bouncebackability is, at present, “somewhat lagging behind” both US and Europe’s recovery.

Central bank digital currencies (CBDCs) also got a look in. All four central banks are stepping up their exploratory work, although they are in the shadow of China’s commitment to its “digital yuan.”

The role of the US dollar as the most important international currency is not likely to change even if there is some CBDC outside the US,” said Kuroda.

“Is China going to beat you to it?” Powell was asked by Galloni, in the context of a potential digital dollar. “Myriad private currencies and currency-like products [are] popping up all over the place and we are working hard to evaluate whether to issue a CBDC, and if so, in what forms,” he responded. “We are doing quite a lot of work on the policy issues, which are quite significant, and also the technological issues, which are quite significant.”

Most central bankers’ view has consistently been that it’s better to be safe than sorry with committing to launch a CBDC. But urgency has entered the Fed’s lexicon.

We are going to publish a paper in the not-too-distant future in which we lay out our preliminary thinking and seek comment from elected representatives and various interested parties,” Powell told the event. “So we want to be in a position to make a well-informed decision on this within a couple of years and I would have thought that that’s timely – it’s better to do this right rather than try to do it fast, as the world’s reserve currency. But nevertheless it’s an urgent matter because digital innovation is moving very quickly. Stablecoins can be very popular and they exist mostly outside the regulatory perimeter.”

The panel were also probed on what they see as the biggest risks to their mandates of financial stability. Climate-change was given air-time by Lagarde, while Powell cited “a successful cyber-attack on a large financial institution or financial market utility”; “the structural problems that we saw in markets during the acute phase of the pandemic” (he added that “we are working on fixing those”); and “in the longer term, both physical and transition risk from climate change for financial institutions”.

In the pre-pandemic world, the ECB Forum on Central Banking has taken place in Sintra, a verdant town on the outskirts of Lisbon. The hope is that, next year, acquaintances can be renewed in person in Portugal and that global economic prospects are being debated with the reality (or spectre) of Covid less of an impediment.

By Ian Hall

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