C3S Fortnightly Column No. F014 /2015
It is an annual jamboree for central bank chiefs. They meet in late August at Jackson Hole, a mountain resort in Wyoming, U.S.A. It is an Economic Symposium held under the auspices of the Federal Reserve of the Kansas City. They hold closed-door discussions with peers over current monetary policies and issues. Admission is restricted and even economists like Paul Krugman are denied entry.
Starting way back in 1978, it assumed an importance disproportionate to its worth.[1] During the Greenspan era, it turned into a glittering mela with participants lavishing praise on the maestro.[2]Financial wizards, bankers and Wall Street analysts would descend on the venue and eagerly await the ambiguous mumbles of Greenspan to get hints about future monetarist policies. Those were the days when central bank chiefs were confident that they could fight the monster (inflation) with the monetary tools at their command.
Unfortunately, the financial crisis which set in around 2008 changed their stance. Over confident chiefs of central banks who felt they could handle any crisis by tweaking monetarist tools were clueless.They realized the inefficacy of conventional tools like interest rate or reserve ratios.
Central Banks had to resort to “non-conventional” policies. These amounted to printing currency notes in trillions of dollars and buying toxic assets from banks. After six trillion dollars down the drain, the western economies remain sluggish, though, of late, cheer leaders produce economic data suggesting signs of growth.
They lowered the interest rates to zero level and gave it a new honorific:Zero Interest rate Policy (ZIRP)! For eight years since 2007, the rate has remained at or below zero level and the question (‘momentous’ or ‘historic’, as described) vexing them now is whether and when to raise it. Every Reserve Board Member, like temperamental ballerinas, has his/her own views. There are hawks at one end the Fed or doves like Narayan Kocherlakota of Fed of Minneapolis at another.Some others express nuanced views. Yellen is caught in between.
The other side of the non-conventional policy was Quantitative Easing (QE). There were three batches or tranches of QEs. This policy was adopted without any consultation with other countries though there was complicity within G-7. Indeed, there were global debates on the impact of QEs on developing countries. The IMF had brought out a numberdocuments or papers on the impact ofQEs or “spillover effects” (The Good, Bad and the Ugly!) on the global economy. Unfortunately, the IMF did not take an unambiguous stand on the adverse implications of those policies despite its new found responsibility for global surveillance. Some of their papers were contradictory. On its part, the IMF senior management was hedging its bets, not wanting to offend the US Fed. Though there was rethinking within the IMF on the role of major banks and the new financial interconnectedness and the risks which their business models entailed, the IMF remained committed to a benign view of transnational banking.[3]To be fair,some of its studies did caution policymakers about the impact of QE withdrawals and how they had to be calibrated carefully. This had gone unheeded.
On the whole, the broad assessment is that QE flows distorted the global financial structures and bloated asset values. Deleveraging of banks, clearing the toxic waste held by them and cleaning up the balance sheets of the Fed and other central banks are daunting tasks which have been sidelined so far. Only the Bank for International Settlements (BIS) came out with studies on the adverse implications of the ZIRP incombination with Forward Guidance (FG) and how they sow the seeds of the next crisis.[4]The ghost of QEs, like Banquo’s, mayhaunt the U.S. Fed and, more importantly, emerging economies for years. The imponderable question whether the US Fed should raise the interest rate (and when) is a part of this problem.
It is unfortunate that the Economic Symposium should shy away from many of these issues afflicting global financial stability and growth. It is true that for a long time Jackson Hole was reserved for academic type discussions.[5]However, its importance rose when Greenspan and Bernanke used it as a platform to indicate policy contours. Unfortunately,at a crucial moment in 2013, Bernanke decided to skip the meeting when the most critical issue of the day, i.e. Fed’s withdrawal of the QE, was up in the air. His remarks made earlier in May 2013 that the Fed would consider “tapering” QE led to global turmoil in developing countries like India.The Fed Chief could have alleviated their distress somewhat by seizing the opportunity and clarifying Fed’s stance.[6]He failed.
Fed Chair Janet Yellen is said to have her own views on communicating Fed’s policies and prefers formal meetings to public platforms. By the end of May this year, a Fed spokesperson said, MS Yellen “does not plan to attend the Federal Reserve Bank of Kansas City’s Jackson Hole Economic Symposium.”[7] She did not attend the Symposium held in 2014. In effect, for three successive years, the Fed Chiefs have not attended the Symposium.
This year’s Symposium had other “no shows.”[8] Last year, only two out of the FOMC’s 10 Members did not attend. This year,half of them were absent. Absentees included important members like Daniel Tarullo, a member of the Board of Governors. Others included Charles Evan of Chicago Fed and John Williams of San Francisco Fed. These absences “may also reflect a cultural change in Yellen’s Fed, which has been seeking to restrict policy discussions to official meetings rather than to project possible plans at events like Jackson Hole.”[9]The ECB Chief Draghi also stayed out.
On all accounts, the global financial is grim. There are heated debates within the U.S. and outside whether the Fed should raise the interest rate and tighten its monetary policy. The rest of the world is kept in suspense. As El-Erian puts, “there is an enormous appetite to hear policy makers’ views on two huge concerns that have shaken market confidence: Spreading evidence of a slowdown in global growth led by increasingly generalized weakness in emerging world (with a particular emphasis on China), and concerns that central banks no longer have sufficient policy ammunition to continue their policy of repressing market volatility.”[10] El-Erian was skeptical whether such issues would be raised at all.Was Yellen repeating Bernanke’s act of 2013 by staying away? It is evident Yellen is tormented by fears and uncertainties attached to raising interest rate. If she raises it, she will be damned; if she does not, again she will be damned. It is an imbroglio intowhich the monetary policies pursued thus far by the US Fed and its allies have led global finance.
Sadly, it seems, the participants at the Jackson Hole Symposium live in ivory towers of their own creation. It has not been a forum for generating new ideas or initiatives to tackle crisis. By and large, papers tend to handle exotic areas at the minutiae or attempt exotic mathematical models suggesting correlation of variables. Many are of doubtful value and resemble parlor games. The Fed officials also do not seem to pay heed to them and go by their own models, assumptions and forecasts. As far as developing countries are concerned, the participants in the Symposium are unmindful of or even indifferent to their concerns. Helene Rey’s paper in 2013 symposium was an exception.
This year, the subject chosen was “Inflation Dynamics and Monetary Policy.” Professors held fort and central bank chiefs occupied back seats as discussants or panelists. There hung a pall of uncertainty over the conference hall, created not just by cross-border flows, but more threateningly, by the newly erupting stock market volatility in China battering stock values across the world. Unavoidably, uncertainty about China dominated the atmosphere and, as Hilsenrath reported[11], most participants listened attentively to the luncheon speech of Prof. David Li of Tsinghua University who has close ties to the PBOC and other government officials. “More revealing than any of his answers was the uncertainty in the room around him – at the most senior levels of economic policy making- about what is happening inside the world’s second largest and for many years its fastest growing economy.” Prof. Li himself had no clues to offer.
Uncertainty was not only about China, it was as much about their ability to understand how inflation works. It did not fall during the years of the crisis; nor bounce back since then when the economy shows signs of recovery. “The conundrum challenges much of what central bankers thought they understood about the world, as well as their ability to do their job.”[12]As Bloomberg explained, “… academics effectively delivered a beating to central banks’ confidence in their ability to predict and manage their key variable by pointing out wide gaps in knowledge about inflation and how it works.”[13] These were contained in papers which we deal in the later part.
An important paper (speech) was by Stanley Fischer[14], Vice Chairman, US Fed. His remarks hogged newspaper headlines and are quintessentially neocon. He debated the earlier (July) decision of the FOMC and wondered whether “inflation will move back to its 2 percent objective over the medium term.” He felt that “inflation will move higher as the forces holding down inflation dissipate.” Explaining the impact of the exchange value of the dollar, he felt that it worked with a time lag. His complex formulations, models and caveats notwithstanding, he seemed to plumb for a rate increase as a preemptive act.
More significant for emerging economies are his views about framing monetary policy decisions. He says, “We are interested more in where the U.S. economy is heading than in knowing whence it has come.” He concedes grudgingly, “That is why we follow economic developments in the rest of the world……At this moment, we are following developments in the Chinese economy and their actual and potential effects on other economies even more closely than usual.”
The sting is in the tail. Fischer adds, “The Fed’s statutory objectives are defined in terms of economic goals for economy of the United States, but I believe that by meeting those objectives and so maintaining a stable and strong macroeconomic environment at home, we will be serving the global economy as well.” In other words, what is good for the U.S. is good for the world!
The paper Simon Gilchrist and three others[15]studies firms’ pricing behavior during financial crisis. It contrasts the behavior of firms having strong financial strength with those which are weaker and explains how during periods of widespread financial distress, “the interaction of customer markets with financial frictions can significantly dampen the downward pressure on prices and account for the stabilization of inflation in the face of significant and lasting economic slack.” The study questions the long-held assumption behind the Phillips curve and adds how “monetary authorities face an active tradeoff between inflation and output stabilization in response to both demand and financial disturbances.” For the neocons, it is a disturbing analysis as its casts doubt on the basic tenet of conventional monetary theory.
Gita Gopinath of Harvard University has a paper[16] which captures the position of the U.S. in the global economy. The basic theme is that imported inflation in response to exchange rate shocks has a time lag of up to two years. Share of imports invoiced in a foreign currency plays a significant role in the time lag. As far U.S. is concerned, it has twin advantages: a dominant share of global trade is invoiced in dollars; and dollar is its national currency. A small fraction of its imports is invoiced in foreign currency. “U.S. inflation is consequently more insulated from exchange rate shocks, while other countries are highly sensitive to it.” Moreover, it is also ‘privileged!’ Sadly, much of the findings in this paper are common place couched in academic garbs. It is known that the U.S. exploits this hegemonic role to its advantage. This has led to several debates on reforming the Bretton Woods legacy and making the system multi-polar, fair and equitable. Gita’s study overlooks entirely the disturbing role of strong U.S. dollar in the inter-connected global financial (banking) system. They don’t reckon that the birds will come home to roost sooner or later. The west, U.S. in particular, “should realize that emerging market distress is not merely a developing world problem. Developed and developing world fortunes are so interlinked that demise of one is sure to bring down the others.”[17]
Jon Faust and Eric M. Leeper argued[18]that monetary policy is not a straightforward affair to be captured by simple mathematical models or equations. While they offered no model to deal with issues, they advised that we should stop looking for simple and straightforward solutions to the challenges posed by monetary policies.
The contribution of Thomas J. Jordan of the Swiss National Bank (SNB) described the problems met with by SNB in the background of Swiss Franc getting strong due to inflows seeking safe heavens or arbitrage. Price adjustments become necessary when firms meet changing conditions both at home and abroad. The current monetary stance of SNB factors in suboptimal and the significantly overvalued currency. The goal is to make the holding of Swiss Franc less attractive and weaken it over time. Switzerland is a unique case by itself for several reasons, past and present, and has not much relevance for other countries. However, when developing countries try to manage their currency rates in their national interest, they are frowned upon!
Dr. Raghuram Rajan did not contribute any paper but took part in discussions. He also gave a press conference in which he “advised the US Federal Reserve against raising the rates when the world is in turmoil.” As far as the stock market volatility in China was concerned, he said, “It won’t affect us as much as other countries in the world.”
On the whole, the Symposium at Jackson Hole worked under two shocks: one of global financial uncertainties; and other of China’s slowdown and stock market volatility. Though the U.S. Fed pretends that the US economy is insulated, the policymakers are overly concerned about China getting back to normalcy. On the whole, it was not comforting for central banks to be advised by economists about the knowledge gaps in their understanding of inflation and the tools adopted. Dark clouds hung over the conference hall and it was no time for celebration, dinners or fly-fishing.
[1]Economist (2014), How Jackson Hole became such an important economic talking shop, 20 August.
[2]K. Subramanian (2005), The adoration of the Fed Chief Alan Greenspan, The Hindu, 2 October and
Subramanian (2013), Hot Air from Jackson Hole, Economic & Political Weekly, September 21,
Vol. XLVIII No.38
[3]Gabor, Daniela (2015), The IMF’s Rethink of Global Banks: Critical in Theory, Orthodox in Practice,
Governance, Vol.2, Issue 2, April.
[4]a Andrew Filardo and Boris Hofman (2014), “Forward Guidance at the Zero Bound’, BIS Quarterly Review,
March.
4b K. Subramanian (2014), Forward Guidance in Retreat, Economic & Political Weekly, Vol-XLIX No. 31,
August 02.
[5]El-Erian, Mohamed A(2015), What to expect from the Fed’s Jackson Hole Meeting, Bloomberg View,
August 24.
[6]Foot Note 2 above.
[7]The Wall Street Journal (2015), Fed’s Yellen Plans to Skip This Year’s Jackson Hole, May 26.
[8]USA Today (2015), Janet Yellen, other big names, no shows at Federal Summit in Jackson Hole, Aug. 26.
[9]Ibid.
[10]Foot Note 5 above.
[11]Hilsenrath (2015), Hilsenrath’s Take: In Jackson Hole, Uncertainty About World’s #2 Economy, The Wall
Street Journal, Aug. 29.
[12]Ibid.
[13]Jeff Black and Christopher Condon (2015), Jackson Hole Has a Worrying Message for Draghi & Co., Bloomberg news, August 31.
[15]Simon Gilchrist, Raphael Schoenle, Jac Sim and Egon Zakrajsek (2015), Inflation Dynamics During Financial
Crisis, March 3.
[16]Gopinath, Gita (2015), The International Price System, Harvard University and NBER, August 20.
[17]Kynge, James and Wheatley Jonathan (2015), Emerging markets: Fixing a broken model, Financial Times
August 31.
[18]Jon Faust and Eric M. Leeper, The Myth of Normal: The Bumpy Story of Inflation and Monetary Policy,
August 18.
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