What do you get when you induct four central bankers who studied history, politics, literature and law into a discourse on inflation? You get a lot of context—the granular texture of economies woven into political and historical milieu.
It may be entirely a coincidence. Monetary policy in four large economic blocs is managed by folks who don’t carry the conventional tag of economist. They do boast of a portfolio rich in experience.
US Federal Reserve Chair Jerome Powell studied politics at Princeton, Andrew Bailey studied history at Cambridge, ECB President Christine Lagarde studied law and political science at Paris Nanterre University and RBI Governor Shaktikanta Das majored in history at St Stephens in Delhi. Tasked with shepherding the economy through turmoil they have wrestled with words to pave the transition. There is no room for jargon but there is no dearth of jaw-boning about uncertainty.
Consider the deployment of the term pause in rate management. The term, which owes its origins to the Greek pausis, represents a temporary break in action or speech. Central banks have been on a pause mode on rate hikes since July and have repeatedly emphasised that rates would be higher for longer. The singular focus of global attention has been whether the central banks are done with rate hikes—and the possibility of rate cuts. In the linguistic armoury of central bankers, the term pause is an instrument of strategic ambiguity.
This is manifest in the approach and stance of central banks. When asked to define the arc of the higher-for-longer option, Lagarde observed, “So how long is sufficiently long? Obviously, we refer to ‘timely manner’, ‘sufficiently long’, but in the same breath I say we shall be data dependent.”
On Wednesday, Powell said, “We remain committed to bringing inflation back down to our 2 percent goal,” and added that the Federal Open Market Committee “is not thinking about rate cuts right now at all”. On Thursday, Bailey pushed back to state: “It's much too early to be thinking about rate cuts,” and added, “We need to see inflation continuing to fall all the way to our 2 percent target.” RBI Governor Das believes, “The need of the hour is to remain vigilant and not give room to complacency.” In a curious display of exuberance, credit swap markets, despite the risk for inflation expressed by central banks, believe rates will be cut around June 2024.
The authors of monetary policy are confronted by a curious conundrum. Following a late awakening that inflation was a real and not transitory risk, central banks ramped up the cost of money between March 2022 and June 2023 to bring down inflation. Action, though, has not catalysed commensurate reaction—inflation has tapered but not sufficiently, given the pace of hikes and steep levels. Evidently, the law of diminishing returns—first articulated in the 18th century by French physiocrat Anne Robert Jacques Turgot—is at play. References to Milton Friedman’s explanation of long and variable lags simply signal that central banks don’t know and cannot specify when they will know.
Meanwhile, the global economy is at an intersection of risks. The war of rich nations on inflation has triggered gyrations in developing and emerging economies. The effects are already visible in markets. The strength of the dollar index reflects the turmoil in the currency markets—the fact that the yen is at record low of 150 to the dollar and at 160 against the euro is a pointer to the pressure on other currencies. While India is in a better place thanks to higher growth, there is no denying the impact on the rupee, reserves and investment flows.
The IMF in its October2023 Outlook observes, “Economic activity still falls short of its pre-pandemic path, especially in emerging market and developing economies.” It has forecast global growth to slow from 3 percent to 2.9 percent next year—well below the historical average of 3.8 percent witnessed during 2000-2019. The IMF’s Global Financial Stability report underlines the risks to banks and to bank lending stemming from the inability of corporates to service loans due to higher funding costs amid a lower growth environment. Rising cost of capital impacts trade, investment and growth. UNCTAD’s Trade and Development Report 2023 warns the global economy “is stalling, with growth slowing in most regions compared with last year”.
This week, Moody’s Investor Service pointed out the measures to keep a lid on inflation with higher-for-longer interest rate regimes “will increase borrowing costs, slow economies and uncover pockets of risk”. It adds that the higher borrowing costs will hamper spending, investment and employment; it forecasts that GDP growth in G20 economies will decelerate from 2.3 percent in 2022 to 1.4 percent in 2023 and 1 percent in 2024.
Central banks must confront geopolitical and existential threats—funding defence and the rising cost of capital for climate change mitigation. The crux of the challenge for monetary policy is to recognise the structural changes. The global economy is transitioning from a demand-constrained narrative to a supply-constrained reality triggered by demographics, climate change and adoption of technology. The context, which scholars of politics, law and history comprehend better, calls for dismantling shibboleths and a re-look at what constitutes an appropriate inflation target for the future.