Jackson Hole Has a Worrying Message for Draghi & Co.

Updated on

Have Central Banks Done Everything They Could?

Mario Draghi may have skipped the Federal Reserve’s Jackson Hole symposium this year, but he can’t dodge its conclusion: central banks can’t steer inflation as well as they thought.

Less than six months into a stimulus program that the European Central Bank president promised would revive consumer-price growth, the euro area is facing renewed disinflationary pressure as China’s economy slows and commodity prices slump. Inflation failed to pick up this month, data showed on Monday, and Draghi may have to downgrade the institution’s forecasts on Thursday.

The newest risk to prices highlights how in the 19-nation currency bloc -- as in the U.S., the U.K. and other industrialized nations -- headline inflation is still far below target even as the economy recovers. Whether that heightens calls for the ECB to step up its 1.1 trillion-euro ($1.2 trillion) quantitative-easing program will depend on how Draghi communicates the complex economic picture.

People think “central banks don’t have a handle on inflation any more and that’s not true,” Jon Faust, professor of economics at Johns Hopkins University, said in an interview at the Kansas City Fed’s annual meeting in Jackson Hole, Wyoming. “Inflation will come back, but the specific timing of that is much more difficult in the current environment.”

Below Target

Euro-area consumer prices rose an annual 0.2 percent in August, unchanged from July, data from the European Union’s statistics office showed on Monday. Economists surveyed by Bloomberg predicted a rate of 0.1 percent.

The ECB forecast in June that price gains would average 1.5 percent next year and 1.8 percent in 2017, provided its stimulus is implemented in full. That would mark a return to the goal of keeping inflation just under 2 percent over the medium term. Economic headwinds could make that outlook harder to achieve.

The ECB’s Governing Council will convene in Frankfurt from Sept. 2 to set monetary policy, and Draghi will present the quarterly economic forecasts at a press conference the next day. Officials including Executive Board member Peter Praet, the ECB’s chief economist, said last week that they’re ready to extend or expand QE if needed.

Knowledge Gap

“The ECB staff macroeconomic projections are likely to show a downward revision in inflation forecasts for both 2015 and 2016, resulting from a stronger euro and weaker oil-price futures,” Philippe Gudin, chief European economist at Barclays Plc in Paris, said in an Aug. 28 note to clients. “We now expect further easing to be announced before year-end.”

Brent crude prices have fallen more than 6 percent in August and are set for a fourth monthly decline. The euro is poised for a 2 percent monthly gain against the dollar, the biggest increase since April.

Central bankers will have an opportunity to discuss their predicament again starting Sept. 4, when they and finance ministers from the Group of 20 nations gather for a two-day meeting in Ankara.

At Jackson Hole, academics effectively delivered a beating to central banks’ confidence in their ability to predict and manage their key variable, by pointing out wide gaps in knowledge about how inflation works.

Harvard University’s Gita Gopinath argued that the relationship between prices and exchange rates isn’t well understood. Boston University’s Simon Gilchrist said that strict inflation targeting can worsen economic outcomes.

Painful Process

Worse still, trying to influence inflation while not understanding it is a “recipe for disaster,” according to MIT Sloan School of Management professor Athanasios Orphanides, himself a former ECB Governing Council member.

Bank of England Governor Mark Carney said that while China’s slowdown and stock-market tantrum won’t impact his institution’s policy path, central banks should still show humility.

“We have to be clear about when we fail,” he said in a discussion session at the Jackson Lake Lodge, inside the Grand Teton National Park. “It is a painful process, but it can bring some credibility.”

ECB Vice President Vitor Constancio also argued that his institution’s policy framework remains relevant, even though it wasn’t able to predict or avert the current period of too-low inflation. Monetary stimulus can reduce the gap between an economy’s potential and actual output, he said.

For Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, the risk remains that there may be less room than claimed to ease policy. Benchmark interest rates at all the world’s major central banks are close to zero and together they’ve pumped trillions into their financial systems since the onset of the financial crisis.

“I look at Japan, Europe, U.K, the Canadians, you just see that more and more countries are getting close to their effective lower bounds,” Kocherlakota said in an interview at Jackson Hole. “This is the challenge facing central banks, which is that aggregate demand is low, and we’re up against the boundaries of the policy space.”