Global economy faces biggest challenge in decades, policymakers warn

Central bankers face a tougher economic landscape than they have seen in decades and will find it harder to stamp out high inflation, senior multilateral officials and monetary policymakers have warned.

This weekend, the world’s leading economic authorities sounded the alarm on the forces opposing the Federal Reserve, the European Central Bank and other central banks as they battle the worst inflation since decades. Speaking at the annual gathering of central bankers in Jackson Hole, Wyoming, many said the global economy was entering a new, tougher era.

“At least over the next five years, monetary policy-making will be much more difficult than it was in the two decades before the pandemic,” IMF deputy managing director Gita Gopinath told the Global Times. Financial Times.

“We’re in an environment where supply shocks are going to be more volatile than what we’ve been used to, and that’s going to generate more costly trade-offs for monetary policy,” she said.

The pace of price growth exploded as supply chain disruptions from Covid-19 lockdowns were met with strong consumer demand fueled by unprecedented fiscal and monetary support since the start of the pandemic . Russia’s large-scale invasion of Ukraine triggered a series of commodity shocks that created even more supply constraints and price hikes.

This dynamic has forced central banks to aggressively tighten monetary policy to ensure that inflation does not take root deeper into the global economy. But given their limited ability to address supply-side issues, many fear they will be forced to cause far more economic hardship than in the past in order to restore price stability.

David Malpass, President of the World Bank, has warned that central bank tools, particularly in advanced economies, are ill-suited to deal with the supply-side inflationary pressures that are driving much of of the recent surge in inflation.

“Rate hikes have to compete with a lot of frictions within the economy, so I think that’s the biggest challenge they face,” he said. “You raise rates in hopes of reducing inflation, but that’s thwarted by so much friction within the supply chain and production cycle.”

Key figures from the Fed and the ECB have made “unconditional” commitments to restore price stability. Fed Chairman Jay Powell warned on Friday that a “sustained period” of slow growth and a weakening labor market were likely.

IMF’s Gita Gopinath said participants were “humbling” in the face of enormous uncertainty in the global economy © David Paul Morris/Bloomberg

Gopinath warned that the ECB faced particularly acute compromises; there was “a real risk” that a stagflationary environment of sluggish growth and high inflation would emerge in Europe, given the intensity of the energy crisis caused by the war in Ukraine, she said.

Malpass said developing economies are also particularly vulnerable as global financial conditions tighten.

“Part of that is because of higher interest rates and they have a lot of unpaid debt, which both increases their debt servicing costs, but makes it harder for them to get new debt,” he said. he declared. “The additional challenge is that advanced economies rely heavily on global capital and energy resources, creating a lack of working capital for new investments. [elsewhere].”

The enormity of the economic challenge facing central bankers was summed up by Changyong Rhee, head of the Bank of Korea, when he said that whether the world would return to a low inflation environment was the “question to a billion dollars”.

Navigating the dynamic atmosphere among Jackson Hole attendees — who, because of the pandemic, had waited two years to socialize and exchange ideas face-to-face — was the overriding concern that the world and the economic relationships that underpin it tend had fundamentally changed.

The sharp change in economic dynamics prompted participants to do some soul-searching. “There is a lot of humility in the room [about] what we know and what we don’t know,” Gopinath said.

The event exposed in great detail the rifts caused by the pandemic and Russia’s invasion of Ukraine.

“We have the energy crisis, we have the food crisis, we have the supply chain crisis and we have war, all of which have profound implications for the economic performance of the world, for the nature in which the world is interconnected and most importantly, for the relative prices of many, many things,” said Jacob Frenkel, the former governor of the Bank of Israel who chairs the board of directors of the Group of 30, an independent consortium of former policy makers.

Complicating matters are doubts about the extent of policy tightening needed in the face of unpredictable swings in supply and, therefore, prices.

“Right now, we have to make our decisions in a context of high uncertainty,” said Thomas Jordan, President of the Swiss National Bank. “The interpretation of current data is difficult and it is difficult to distinguish between temporary and sustained inflationary pressure.”

According to the ECB’s Schnabel, the next few years are likely to be known as the “great volatility” – unlike the past two decades, which economists have called the “great moderation” because of the relatively quiet dynamics.

Many officials have come to believe that the structural forces that controlled price pressures – primarily globalization and an abundant supply of labor – have reversed.

“The global economy appears to be on the cusp of a historic shift, as many of the global supply tailwinds that have been limiting inflation look set to turn into headwinds,” warned Agustín Carstens, chief executive of the Bank for International Settlements. “If so, the recent acceleration in inflationary pressures may prove more persistent.”

Skeptics of this view say they are confident that the world’s major central banks will be able to stave off entrenched high inflation.

“The issue central banks need to focus on is not establishing the credibility of inflation,” said Adam Posen, president of the Peterson Institute for International Economics. “The problem is remaking inflation strategy and targets for a world where you’re going to have more frequent and larger negative supply shocks.”

The 2% inflation target that central banks in advanced economies have mostly adhered to for decades was brought up repeatedly throughout the conference, with economists suggesting it may need to be adjusted to fit. adapt to a more fractured global economy.

Long before inflation spiked, the Fed announced in 2020 that it would target inflation at an average of 2% over time, to catch up on past periods of undershooting the target. Last year, the ECB said it would tolerate inflation temporarily above 2% at certain times.

Many economists have advocated an inflation target of 3%. According to Stephanie Aaronson, a former Fed employee now at the Brookings Institution, this would give central banks more flexibility to look past supply shocks and support the economy during a downturn.

“If you get down to 2% and you can reduce the amount of low growth you need and also switch to a better diet long term, because you’re less constrained by the zero lower bound, that sounds like a winner to me. -winner,” said Maurice Obstfeld, the former chief economist of the IMF, in an interview.

When and how a central bank like the Fed and other central banks approach changes to their mandates will be critical, given their precarious control of inflation and the risk that household and business expectations for future price increases can be confirmed.

Karen Dynan, an economics professor at Harvard University who previously worked at the US central bank, said it would be “very risky” for the Fed and its counterparts to broach the subject until they brought inflation under control.

“They need to do everything they can to preserve their credibility – and perhaps in some cases restore their credibility – but they’re going to have to think hard about what that new goal should be.”

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