Central bankers grapple with changed landscape at Jackson Hole

It was the head of Singapore’s monetary authority who best summed up the biggest fear gripping the virtual Jackson Hole conference this year.

“We are not going back to the same world,” Tharman Shanmugaratnam warned.

“We’ve got to avoid a prolonged period of high levels of unemployment, and it’s a very real prospect. It is not at all assured that we will get a return of tight labour markets even with traditional macroeconomic policy being properly applied.”

The notion that central bankers need to face the reality of permanent upheaval and long-term economic damage by deploying new tools and dovish policies was the main theme of the Federal Reserve’s flagship annual event.

Among the research papers unveiled at Jackson Hole, one presented by Laura Veldkamp of Columbia University suggested that the coronavirus pandemic was, like the financial crisis, a “tail event” likely to transform the behaviour of consumers and business for years to come.

Another, by Nicholas Bloom of Stanford University, focused on the adverse impact of the uncertainty created by the Covid-19 outbreak around the globe, calling it “a major impediment to a rapid recovery”.

Against this backdrop, top policymakers discussed their own strategies in addressing the crisis and its fallout. Jay Powell, the Fed chair, began by announcing a long-term strategy for the US central bank that includes a much more lenient approach to inflation — an average 2 per cent target that will allow some overshooting, coupled with a more dogged focus on achieving the tightest possible labour markets.

This is likely to keep interest rates close to zero for a long time, possibly many years.

“The economic question we had to answer was how to adapt our framework to what we really had learned since the global financial crisis, during that long expansion”, Mr Powell said.

It is unclear how far the Fed’s move will serve as a model for others. The European Central Bank is conducting a strategic review of its own. This has been extended until the middle of next year and is now likely to be subject to extra pressure to follow the Fed’s lead by considering whether to adopt its own average inflation targeting.

Two members of the ECB governing council said it was likely to consider such a move. But they added that the idea would probably be opposed by some of the more hawkish council members such as Jens Weidmann, head of Germany’s Bundesbank, which is renowned for being deeply fearful of runaway inflation.

“I think we will look at it,” said one ECB council member. “But the idea of a substantial overshooting on inflation leads to a worry that the governing council would not have the moral fibre to adjust interest rates enough to correct it — so yes, the Bundesbank will be nervous about the idea.”

“The problem for the ECB is, once again, how does it position itself relative to the Fed,” said Gilles Moec, chief economist at the French insurer Axa. “This gives the impression that the Fed is ahead of the curve and it is an issue that I think the ECB would prefer not to have to deal with right now.”

Meanwhile, Andrew Bailey, the governor of the Bank of England, disputed the notion that central banks were running out of ammunition in the crisis. “We are not out of firepower by any means, and to be honest, it looks from today’s vantage point that we were too cautious about our remaining firepower pre-Covid,” he said.

He also suggested that it would be critical for the BoE to preserve room to use its balance sheet aggressively in the next crisis, which might mean shrinking it ahead of any future interest rate rises.

“Bailey’s argument was that QE is a really powerful tool, especially when markets are disorderly — so some weight should be put on reducing balance sheets so at the end we have space to start buying again. No one’s really made that argument the same way”, said Kristin Forbes, an economics professor at MIT.

Some in the audience disputed the gloomy predictions of a long-term economic hit from the pandemic, suggesting it was at odds with the recent rally in equity markets, as well as some evidence of a swifter rebound than feared.

“There’s a risk that we are overdoing the gloom and doom and that we will ultimately find that this huge economic hit will be much more temporary than incorporated in most forecasts,” Jan Hatzius, chief economist at Goldman Sachs, said in one of the question-and-answer sessions.

But one key factor that occasionally entered the discussions and is top of mind for many policymakers is the need for fiscal policy to remain aggressive to support monetary policy actions, ensure demand does not collapse, and mitigate any heightened inequality due to the crisis. In the US, in particular, massive initial fiscal support has waned significantly in recent months and is in danger of evaporating completely if a new relief package is not approved.

“We cannot afford at the current juncture a repeat of the fiscal tightening that we saw in the great financial crisis,” said Laurence Boone, chief economist at the OECD.

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