A Central Bank Puzzle for Our Era: What Gives?
Maybe central banks aren't quite so powerful after all.
Might we be overestimating their ability to bring inflation back to their target, typically 2 percent, at least in the near term? They've been chastised for that failure, but the admonishment could be wide of the mark.
Perhaps inflation should be given longer to climb?
Should monetary policy pay more attention to financial conditions and stability? (Hard to argue with that, given the debacle of 2007-2008.)
More fundamentally, could policy makers be hostage to powerful trends built up over decades -- like technological innovations and an increasingly global economy? These forces have little to do with where the Federal Reserve, the European Central Bank or the Bank of Japan set their benchmark rates.
These are among the issues probed by Claudio Borio, a top official at the Bank for International Settlements, a kind of central bank for central banks. In a speech Friday, Borio said he would be deliberately provocative; he didn't disappoint.
It's a timely and significant contribution to the intensifying debate about why, eight years into a global expansion with unemployment very low, inflation and wages just aren't firing.
The scrutiny of policy was on full display this week when Fed Chair Janet Yellen acknowledged it's a bit of a mystery why inflation is not only stuck below target, but going the wrong way: south.
If some of the issues raised by Borio are indeed to blame, the venerable cohort of Yellen, Draghi, Kuroda & Co. may not be the prime suspects.
He devotes some attention to China's entry into the world economy, and the forces of globalization that contributed to its rise and to whose rise it contributed. This is usually discussed, at least in the U.S., in the context of cheaper goods and the downward pressure put on inflation. Critically, Borio notes that this expanded not just an international market for goods and services, but of labor as well.
"Is it reasonable," he asked, "to believe that the inflation process should have remained immune to the entry into the global economy of the former Soviet bloc and China and to the opening up of other emerging market economies? This added something like 1.6 billion people to the effective labor force, drastically shrinking the share of advanced economies, and cut that share by about half by 2015."
It strikes a chord given the exasperated tone emerging from central banks. I began thinking more about this after hearing Philip Lowe, governor of the Reserve Bank of Australia, decry mediocre wage growth in June and suggest that workers demand higher pay.
Stephen Jen, a classmate of Lowe's at the Massachusetts Institute of Technology and a director of Eurizon SLJ Capital Ltd. in London, said in response that the relationship between labor and capital changed profoundly after China entered the World Trade Organization in 2001. All economic models, including those that link employment with wages, needed to be recalibrated, he said. Borio's remarks would indicate that Jen was on to something.
And so was Yellen this week, especially in her pretty candid response to a question from Chris Condon at her press conference this week: "I will not say that the committee clearly understands what the causes are."
Borio appears to have some sympathy for that view. Nonetheless, we shouldn't abandon our quest to find out what gives. It's not just an American issue; it's one of the big economic policy questions of the decade.
More provocation, please.
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