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Every year, central bankers, policymakers, academics, and economists convene in an unlikely place in the US state of Wyoming to deliberate about important matters. Observers hang on the lips of the attendants of the Jackson Hole summit, trying to glean nuggets of wisdom and insights about the state of the global economy. In 2021, many pundits thought that inflation would be transitory. This year, the discussions revolved around how to maintain credibility in the fight against persistent inflation.
Today, central bankers are in a double bind. Initially, they got rapped on the knuckles for belittling inflation, now they are criticized for a panicked U-turn. With the US Federal Reserve already having made fast and forceful hikes to the main lending rate, would now be the time for yet another step change? Those hoping that Fed governor Jerome Powell might announce a more cautious stance in Jackson Hole, i.e. a rethink of the US Fed’s tightening policy, were disappointed. Powell didn’t yield an inch, instead continuing to fly his newly adorned inflation-fighting colors (perhaps remembering General Custer’s holding out in nearby Montana some 150 years ago). He stressed that it’s both possible and necessary for central banks to keep prices low and stable, and reaffirmed his commitment to a tight monetary policy.
There is some room for debate here. Prior to the pandemic, the US Fed failed to reach its 2% inflation target with then-chairwoman Janet Yellen saying in 2017 that she and her colleagues didn’t fully understand inflation. The unemployment rate had been falling for several years, yet inflation was not increasing.
So, are key rates being hiked for the right reason? That’s not clear. The International Monetary Fund’s (IMF) senior economist Gita Gopinath recently observed that current economic models cannot account for the sharp rise in inflation. We are also aware of British-American economist David Blanchflower’s work1, which has already debunked the so-called Phillips curve – a model that predicts a higher rate of increase in wages with lower unemployment. Critics of the Fed’s tightening action argue that the new policy only adds pain to an ongoing economic slowdown, and they have a point. What we do know with a high degree of certainty is that inflation will come down as the global economy cools.
When Powell gave his speech, financial markets promptly gave up much of the gains they had racked up during the summer months. But his “Last Stand” (remember General Custer) may not be so bad for investors after all. Once we leave the wobbly ground of negative interest rates, yield-hungry investors will warm to fixed income again, and those seeking risk mitigation can return to the classic 60/40 portfolio.
With the powerful Fed chief blazing the tightening trail, other heads of central banks will follow or have already done so. This year’s Jackson Hole may come to symbolize the sensible end of a decade of easy money.
1. The Wage Curve, David Blanchflower and Andrew Oswald, MIT Press, 1995