Three Lessons from Jackson Hole for Governments and Central Banks
The age of cheap debt is over, monetary policy communication is changing and the future of digital finance still rests on central bank money. A commentary by Ignazio Angeloni
Expectations for this year’s Jackson Hole conference were higher than usual, and they were not disappointed. Kevin Warsh, the new chair of the Federal Reserve, set out a strong and convincing view of economic trends and of the central bank’s role in tackling inflation, which has now remained above the Fed’s 2 per cent target for five years.
For the moment, concerns that Powell’s successor might begin his tenure in a weak position, hostage to political pressure and disagreements within the Federal Open Market Committee, which he chairs, have been dispelled.
Less prominent in the media, but no less important, was the session on digital payments, which helped clarify a much-debated subject still marked by ambiguity and disagreement.
Three main messages emerged. They concern the United States, but also governments and central bankers around the world.
The first is that the era in which public and private borrowers could rely on low interest rates to accumulate debt without worrying about its sustainability is over.
Long-term interest rates around the world have reached or surpassed the levels seen before the two great crises of the 21st century, the financial crisis and the pandemic, and continue to rise. In the meantime, debt levels have increased enormously, creating a potentially explosive combination for the financial system.
For governments on both sides of the Atlantic, the message is clear: debt sustainability is once again paramount.
In Europe, the terms of the equation are different, but not necessarily more favourable, since lower interest rates are accompanied by weaker growth.
This also has implications for central bankers.
If yields remain structurally higher across all maturities, it is difficult to see how the equilibrium interest rate, the natural rate known as “r-star” at which monetary policy is considered neutral, can remain unchanged. The ECB recently reaffirmed that the natural rate in the euro area is zero in real terms, but those estimates are likely to rise alongside market yields.
On central bank communication, Warsh reiterated his preference for a restrained style, in which the central bank speaks sparingly and, above all, does not offer guidance on the future path of interest rates, the practice known as “forward guidance”.
Because the central bank draws information from the market, there is a risk that the interaction between the two begins to resemble a room lined with mirrors, where everything is reflected and reality itself is lost.
Warsh did not discuss interest rates. Instead, he focused entirely on the state of the economy, inflationary pressures, financial conditions, which he said he would “struggle to describe as restrictive”, and the Fed’s responsibility to curb inflation. The message to markets nevertheless came through loud and clear, with the dollar strengthening and yields rising.
Warsh’s criticism also extends to the practice of basing monetary policy decisions on the latest economic figures, the “data-dependent” approach championed by his predecessor Powell and by ECB president Christine Lagarde. According to Warsh, the latest data are imprecise and misleading.
Policymakers must interpret the underlying trends. This means fewer automatic responses, less backward-looking decision-making and greater responsibility for the central bank to guide markets through forward-looking analysis and interpretation.
These criticisms apply, to some extent, to all central banks, although their practical significance will depend on how they are implemented.
The distinction between data dependency and the interpretation of trends is less clear-cut than it may appear, since every trend must still be tested and adjusted in the light of new data.
Ultimately, the metaphor of the mirrored room could also apply to the analytical approach advocated by the new Fed chair. The debate will continue, but after Jackson Hole, Warsh’s arguments will provide an important point of reference.
Isabel Schnabel, a member of the ECB’s Executive Board, addressed the future of wholesale payments during the conference’s session on payment systems.
The central message from that discussion was that, following the cryptocurrency revolution, the tokenisation of financial instruments and the introduction of distributed ledgers, the emerging approach is to combine these innovations with settlement in central bank money.
The ECB is at the forefront of this effort to combine efficiency and security through its Pontes project, which connects TARGET Services to distributed ledger technology, and Appia, which extends the same principle to other financial instruments.
These innovations are therefore likely to bear fruit mainly in wholesale payment systems, while retail systems have already reached a mature stage. One detail was particularly telling: Schnabel did not mention the digital euro once.
A previous version of this article was published in the Italian weekly La Repubblica - Affari e Finanza
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