Central bankers were in reflective mood at last week’s annual Jackson Hole confab. At the 2022 meeting, when inflation was close to 40-year highs, the message from monetary policymakers was simple: interest rates must go higher. This year, while inflation remains “too high”, in the words of US Federal Reserve chair Jay Powell, higher rates have at least begun to pinch demand and price growth is easing. The discussions instead shifted towards the evolving global economic landscape, from the climate transition to geopolitical tensions. The message: central banking is only going to become more complex.
When monetary policymakers set interest rates to hit their inflation targets, they must assess where they think demand is relative to supply. Put simply, if demand is estimated to be higher than supply, elevated interest rates help to cool an overheating economy — and vice versa. Economic upheaval, however, makes this calibration significantly harder.
The past three years have brought substantive change to the global economy. The pandemic has left long-lasting scars, including higher levels of worker inactivity in Britain, for example. Geopolitical ructions have led to the rewiring of supply chains, and the climate transition is driving big shifts in global energy markets too. Meanwhile ageing demographics, the AI revolution and rising demands on government spending adds more moving parts, with implications for both supply and demand. Powell described rate-setting today as “navigating by the stars under cloudy skies”.