The Fed is fighting symptoms of a problem it cannot fix. In his opening remarks at this year’s economic policy symposium in Jackson Hole, Fed President Powell made it very clear that trade policy is out of his control. “Setting trade policy is the business of Congress and the Administration, not that of the Fed.” However, as trade policy uncertainty affects the outlook for employment and inflation, it becomes a concern for monetary policy. How to fit trade policy uncertainty into the Fed’s monetary policy framework remains an open question, as no recent precedents to guide policy responses exist, so Powell. More generally, the Fed is facing the challenge of “how to best promote sustained prosperity in a world of slow growth, low inflation and low interest rates”. The Jackson Hole economic policy symposium provided a platform for academics and central bankers to extensively discuss current challenges for monetary policy. Here, we present a short summary of the key issues discussed .
Athanasios Orphanides presented suggestions to improve monetary policy strategy and communication, based on which the conference participants discussed the implications of a data-dependent central bank. Orphanides highlights the importance of clear communication and, at the same time, criticizes that some phrases, which are currently used in the FOMC statement, lack clarity (“data dependent”, “act as appropriate”, “balanced approach”). Particularly in an environment of uncertainty, which international trade policy currently provides, clear communication is of utmost importance. Otherwise, discretionary policy decisions may be misunderstood. “Discretion may invite perceptions of political interference that damage the credibility of the central bank and threaten its independence”, reminding of President Trump’s outspoken preference of the Fed to lower interest rates. Orphanides highlighted three areas of improvement. First, Orphanides suggests the adoption and communication of a concrete monetary policy strategy, to limit meeting-by-meeting discretion. A simple policy rule, for instance, could serve as a benchmark for monetary policy decisions. Second, a quarterly monetary policy report could bring more clarity on the FOMC members’ projections, as compared to the current Summary of Economic Projections. Reducing the frequency of FOMC meetings to quarterly would be a meaningful consequence. Third, a clear communication of uncertainty associated with the economic outlook would be preferable. This could be achieved by incorporating information about the probability distribution of individual projections, or the addition of alternative risk scenarios.
Òscar Jordà and Alan M. Taylor filled a panel on Monetary Policy Divergence with a paper titled Riders of the Storm trying to identify the causes and consequences of monetary policy divergence. They argue that comparing the level of policy rates among advanced economies is insufficient to assess monetary policy divergence. Instead, the stance of monetary policy is described as the difference between the short-term real interest rate and the short-term neutral, or natural, real rate of interest, commonly known as r*. Similar to other studies, Jordà and Taylor find a significant decline of r* since the mid-1980s, when the global natural rate of interest reached a peak around 4 %, falling to -1 % until 2018. This time-varying characteristic of the natural rate of interest contrasts the assumption of popular Taylor rules which predominantly reject the role of the natural rate. The empirical evidence, presented by Jordà and Taylor, therefore, suggests that the natural rate does matter for monetary policy decision making. Further, they argue that “interest rate setting is driven by factors outside policymakers’ control”. Besides the development of the domestic natural rate of interest, also changes to the global natural rate determine interest rate setting. According to the authors, the monetary policy stance, which can be directly influenced by central banks, can only explain about 40 % of the variation of short-term interest rates, 60 % is out of their hands. With respect to the dispersion of monetary policy across major advanced countries, the authors find a hump shaped trend. While the business cycles have synchronized quite continuously over time, the dispersion of monetary policy widened after the break-up of Bretton Woods and only narrowed again once a new inflation-targeting consensus was established. Increased real and financial integration requires central banks to adopt a global perspective.
An international perspective has also been emphasized by Kalemli-Özcan who presented her research on US Monetary Policy and International Risk Spillovers. Her paper challenges the yield-oriented explanation for international capital flows. The relationship between interest rate differentials and capital flows depends on local and global risk perceptions. A positive effect on capital inflows from increasing yield spreads can only be identified once risk perceptions are accounted for, particularly so in emerging market economies (EME). Kalemli-Özcan, thus, argues that capital flows are sensitive to risk perception rather than yield-oriented and, particularly, affected by changes in US monetary policy. In contrast to advanced economies, yield-spreads in emerging markets increase following a tightening of US monetary policy, as country-specific investment risk increases in EME. If exchange rates are not freely-floating domestic monetary authorities need to raise interest rates by more than 1:1, which might raise country-specific risks through tighter financial conditions. Fixed exchange rates are, thus, harmful in a world characterized by international risk spillovers. In order to decrease risk-sensitive capital flows, the author recommends reducing country specific risk by improving institutional quality, improve transparency, governance and accountability, fight corruption, protect institutional integrity, improve bureaucratic quality and emphasis central bank independence.
The international perspective seems to have been dominant at this year’s Jackson Hole meeting. During the final panel, covering financial markets, Arvind Krishnamurthy and Hanno Lustig presented their research on the US dollar exchange rate and its interrelatedness with the US treasury market (Mind the Gap in Sovereign Debt Markets: The US Treasury basis and the Dollar Risk Factor). They argue that monetary tightening leads to an appreciation of the US dollar through increases in the convenience yield, which reflects the safety and liquidity attributes offered by US Treasuries. There is no similar convenience yield channel for the Euro or the Yen, in response to shocks to safe asset demand. Since the 2008 financial crisis, the dollar exchange rate’s sensitivity to the convenience yield has even increased. Moreover, the authors argue that the convenience yield drives the US credit cycle. Foreign investors’ demand for safe and liquid US dollar assets, incentivize private US bond issuers to take on more leverage and reduces the fiscal discipline of the public sector. Further, foreign borrowers are incentivized to issue dollar-denominated assets leading to currency mismatches on their balance sheet, which can cause increases in the debt burden once the dollar appreciates. The global financial cycle is a US dollar cycle, they conclude.
Overall, the 2019 Jackson Hole Economic Policy Symposium was dominated by a focus on international drivers, spillovers and coordination of monetary policy. According to Mark Carnes, Governor of the Bank of England, the mainstream view that the combination of inflation targeting central banks and flexible exchange rates best serves domestic mandates to stabilize inflation and maintain output at potential is eroding. The importance of cross-border spillovers has risen substantially, yet with the US dollar as the currency of choice for international trade, the effectiveness of adjustments through flexible exchange rates is limited. Divergence of US monetary policy with the rest of the world, thus, inherits challenges for other advanced economies and, particularly, emerging market economies. Thus, international coordination, particularly with respect to the provision of a global financial safety net, needs to be strengthened and local financial stability in advanced economies to be perceived as a global public good. Over the long-run Mark Carnes suggests building an international monetary and financial system with multiple reserve currencies to increase the supply of safe assets and lower the synchronization of trade and financial cycles.
 The agenda of the 2019 Jackson Hole Economic Policy Symposium including the materials presented, is made available by the Federal Reserve Bank of Kansas City (https://www.kansascityfed.org/publications/research/escp/symposiums/escp-2019).
Martin Ertl Franz Xaver Zobl
Chief Economist Economist
UNIQA Capital Markets GmbH UNIQA Capital Markets GmbH
Chief Economist, UNIQA Capital Markets GmbH
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