Speaker 1: Hello, and welcome back to Stephanomics, the podcast that brings
Speaker 1: you the global economy, and this week also brings you
Speaker 1: the Bloomberg New Economy Forum. It was the final day
Speaker 1: of the Forum today and I wanted to play you
Speaker 1: most of a panel that I moderated about the end
Speaker 1: of easy money policy making for an inflationary era. We
Speaker 1: had a pretty high class set of speakers. Axel Weber,
Speaker 1: the former head of the bundas Back now a senior
Speaker 1: adviser to UBS, the investor Davode Sarah, chief executive officer
Speaker 1: and founder of Algebra's Investments, and Geter Gopinath, formerly the
Speaker 1: chief economist of the i m F, now it's first
Speaker 1: deputy Managing Director. Of course we're talking about inflation. We
Speaker 1: could have spent a lot of time talking again about
Speaker 1: why central banks have got things so wrong, but I
Speaker 1: was pretty keen to look ahead. What's the consequences of
Speaker 1: this inflation that we're seeing and does it mean we
Speaker 1: have to rethink some of the macro policy tool kit
Speaker 1: that we developed for a rather different time. I started, though,
Speaker 1: by asking Peter Governa, with her perspective at the International
Speaker 1: Monetary Fund, whether collectively policymakers had done enough to confront inflation.
Speaker 1: I mean, stephaniely, without a doubt, one of the biggest
Speaker 1: challenges economies around the world are facing is inflation uh
Speaker 1: and to bring inflation down at the time when growth
Speaker 1: is also slowing for other reasons because of other forms
Speaker 1: of supply sharks. I think what central banks around the
Speaker 1: world have clearly recognized is that they need to move
Speaker 1: in the determined fashion to durably bring inflation down. If
Speaker 1: you see the total amount of rate increases that we've
Speaker 1: seen in the US this past year, this is their
Speaker 1: few parallels in terms of the last several decades to
Speaker 1: see this much of an increase in such a short
Speaker 1: period of time, But I was needed to address the
Speaker 1: kind of inflation that we haven't seen in over four decades.
Speaker 1: The US FED is at the point where they've raised
Speaker 1: interest rates around basis points. They are very likely to
Speaker 1: raise interest rates another round before the end of this year,
Speaker 1: and then the question is what comes next, And I
Speaker 1: think the question is more about how long are you
Speaker 1: going to keep these rates at the at the levels
Speaker 1: that they've moved them too, and we see a need
Speaker 1: to keep it at over four percent for all of
Speaker 1: twenty twenty three to be able to bring inflation down durably,
Speaker 1: and like you said, it's very important to do that
Speaker 1: because it's extremely regressive high levels of inflation. Now, there
Speaker 1: are countries at other different points in their cycle, but
Speaker 1: I focused on the US because in terms of spiller
Speaker 1: was to the rest of the world, US policies had
Speaker 1: the biggest effect. Actually, you're the former central banker on
Speaker 1: this panel, and we should record that you were on
Speaker 1: the record early in morning about inflation at the end
Speaker 1: of But you have now had at least ninety central
Speaker 1: banks raised interest rates this year, at least half of
Speaker 1: them basis points in a single go, which most of
Speaker 1: them have not done before. Are we now at a
Speaker 1: point where central banks can have a more leisurely We're
Speaker 1: not talking pivots, but a more leisurely pace. No. I think,
Speaker 1: as Gito was indicating as a central banker, seventy five
Speaker 1: basis point moves are usually conducted over the last couple
Speaker 1: of decades. Only on the way down. When you are
Speaker 1: ever been hit by a shock and you were behind
Speaker 1: the curved by construction because something unexpected in the economy,
Speaker 1: like in the financial crisis, on the way up. I
Speaker 1: think it's a mirror image and and we don't want
Speaker 1: to talk about the past, but it's a bit of
Speaker 1: a mirror image of being laid in my view, by
Speaker 1: design from the inflation targeting regime that was adopted and
Speaker 1: therefore having to do faster steps because inflation didn't just
Speaker 1: rise from below two percent to just above two percent
Speaker 1: or three percent or four percent, when all the way
Speaker 1: up to double digit and that's where I think a
Speaker 1: lot of action was needed. If if central banks have
Speaker 1: a dual mandate, which many of them have explicitly or implicitly,
Speaker 1: the most violated objective in the central bank objective function
Speaker 1: at the moment is inflation. It's way out of line
Speaker 1: with the target, whilst the employment and the economy has
Speaker 1: been holding up relatively well so far. And there is
Speaker 1: a new shock with the war in Ukraine that has
Speaker 1: added another negative supply shock to an already strained environment
Speaker 1: that that central banks were facing. So I don't think
Speaker 1: they're done. I think they've got some more work to do.
Speaker 1: I think the belief in markets that central banks will
Speaker 1: go and then come back in next year is in
Speaker 1: my view, uh, both premature and not ideal. From a
Speaker 1: central bank point of view, and with GETA, they probably
Speaker 1: have to keep rates at which they go over the
Speaker 1: spring next year at that level for the remainder of
Speaker 1: the year and into twenty four to bring inflation down
Speaker 1: towards they're objective, and it will take them two years
Speaker 1: to really be in the vicinity again of their objective
Speaker 1: bearing further shocks. But bearing further shocks is a very
Speaker 1: brave assumption, and a lot of the things that are
Speaker 1: in the pipeline, the transition to a greener economy, all
Speaker 1: of this will have inflationary impacts on energy prices and
Speaker 1: in other parts of life. So I think there is
Speaker 1: a likely scenario where you will see repeated shocks that
Speaker 1: will keep inflation eye and more persistently high, despite central
Speaker 1: banks having adjusted monetary policy and having raised rates substantially
Speaker 1: at least for the next year or two. And as
Speaker 1: we know it's been discussed this week, it's not just
Speaker 1: the moved to net zero, it's climate change itself also
Speaker 1: produces more volatile inflation. I think we're pretty clear on
Speaker 1: that Tai day from the investors standpoint, where where do
Speaker 1: you think we are on this road? I think investors
Speaker 1: right now have this view, at least what's priced in
Speaker 1: the future, the rates are going to go lower. But
Speaker 1: here the beauty of Bank of England that has calculated
Speaker 1: numbers for the last five century is never in developed
Speaker 1: markets when core inflation passes five for more than twelve months,
Speaker 1: they're being able to bring the core inflation number below
Speaker 1: too in less than ten years. Only once in history
Speaker 1: in the last century in less than five years. So
Speaker 1: if history is of any help, I think rates are
Speaker 1: going to stay higher for longer, and there are free
Speaker 1: reason for it. The inflation shock comes from free main area.
Speaker 1: The first one is green transition. The second is the
Speaker 1: decaupling of the supply chain globally for geob political reason.
Speaker 1: And further, remember green transition require materials which are no
Speaker 1: longer in an abundant space. You know, think about copper.
Speaker 1: We'll be looking for copper for two thousand years. We
Speaker 1: need to find more copper in the next twenty years
Speaker 1: that we've been found in the last two thousand years.
Speaker 1: And when you add then the add there's consequences of
Speaker 1: getting in transition and climate change on food, you add minerals,
Speaker 1: and then you add the war, you're creating an effect
Speaker 1: that's why I think inflation is going to be strategy.
Speaker 1: It's slightly higher. Then if you think that we had
Speaker 1: in developed market US and Europe, now people have better
Speaker 1: balance sheet. You see it in the US, so a
Speaker 1: recession is likely to be less, you know, shallow. We're
Speaker 1: not going to be a harder recession. And as a
Speaker 1: result of thin, central bank can keep rates higher. So
Speaker 1: I think if the market is wrong, rates ain't going
Speaker 1: to go down as stats as people think, in the
Speaker 1: sense it is running together both things, as the current
Speaker 1: inflation shop where people are dealing with, and then these
Speaker 1: longer term trends, and people have thought that maybe this
Speaker 1: was a sneak preview to those, But he's kind of saying,
Speaker 1: we're already there, guitar, Do you buy into that that
Speaker 1: we we're already in this structurally higher inflation world. Not fully.
Speaker 1: I would say the following, which is what is true,
Speaker 1: is we are likely entering a period where supply sharks
Speaker 1: will play a bigger role then they did in the
Speaker 1: last two decades. And supply sharks include sharks that come
Speaker 1: from a climate. But also I think risks in terms
Speaker 1: of economic fragmentation around the world. What could happen to
Speaker 1: global trade. I think those risks could play an important role.
Speaker 1: So we probably are entering an error where for central
Speaker 1: banks they really have a trade off to deal with.
Speaker 1: They didn't have a trade off. I mean it was
Speaker 1: for the last couple of decades they could keep reducing
Speaker 1: the unemployment rate and not see any inflation. They didn't
Speaker 1: really have a trade off to deal with. But now
Speaker 1: they actually are likely to have a most serious trade
Speaker 1: off to deal with. But the question of the inflation
Speaker 1: that we've seen now, I wouldn't not start with the
Speaker 1: green transition of climates as being the leading factor for it.
Speaker 1: I think what we had was a very unique period
Speaker 1: of the pandemic now the war and we've seen very
Speaker 1: extraordinary recoveries that have come along with very large amounts
Speaker 1: of support that was provided during the worst time of
Speaker 1: the pandemic in terms of both money, ships policy support,
Speaker 1: and also especially fiscal policy support, so people with high
Speaker 1: levels of savings, and now you've seen that money being
Speaker 1: spent alongside you do have a supply side problem to
Speaker 1: which is that in markets like the US and the UK,
Speaker 1: labor supply hasn't come back to what it was pre pandemic.
Speaker 1: You still have the pandemic hitting other parts of the world.
Speaker 1: In China, we in cases going up that's affecting supply chains.
Speaker 1: So I think those are the main factors. I still
Speaker 1: do believe monetary policy works in the traditional way of
Speaker 1: reducing demand by raising interest rates, and we are seeing
Speaker 1: that happen in in the U S and other countries.
Speaker 1: It's going to take some time. I don't think it's
Speaker 1: going to take many, many decades like that. And they said,
Speaker 1: but again, um, so I would make that distinction. I mean,
Speaker 1: but what we're trying to solve now and what the
Speaker 1: risks are there on the horizon? Accellent. We're focusing on
Speaker 1: policy making. Um clearly we've seen I mean the UK
Speaker 1: had some of its own problems, but it also there
Speaker 1: was a structural issue which many countries face of balancing
Speaker 1: now in this more challenging world, the fiscal and the monetary.
Speaker 1: Do you think we have the right sense of what
Speaker 1: that how fiscal and monetary needs to work together or
Speaker 1: not work together in this environment. Yes, So two things,
Speaker 1: and I need alluded to it. One thing you have
Speaker 1: to see is that what happened after COVID, namely a
Speaker 1: massive expansion of balance sheets of government and finance, largely
Speaker 1: by emissions and purchases of sovereign debt into the balance
Speaker 1: sheet of a central bank. Was a coordinated extension of
Speaker 1: balance sheets on the sides of the central bank, roughly
Speaker 1: to the tune of of global GDP and of governments,
Speaker 1: and a lot of that, unlike in the financial crisis,
Speaker 1: was going to private households in forms of paychecks and
Speaker 1: really increased demands. So there was quite a demand stimulus
Speaker 1: that we saw necessarily so in but he was kept
Speaker 1: in place, at least from the monetary side, way too long,
Speaker 1: and I think that is part why we saw inflation.
Speaker 1: The other side we haven't talked about is the balance
Speaker 1: sheets really what will happen with them in the future. Now,
Speaker 1: if you look at the S and P five, then
Speaker 1: you look at the you know, added balance sheet of
Speaker 1: the major three central banks Europe, Japan and the US,
Speaker 1: you see a very high correlation between how financial markets
Speaker 1: have been performing and the liquidity put into the system
Speaker 1: by the central banks. Now, going forward, central banks don't
Speaker 1: just raise rates, they're also reducing their balance sheet. And actually,
Speaker 1: if you look at Europe, because some of the liquidity
Speaker 1: was provided through long term financing, operations that have an
Speaker 1: end date and not been prolonged. A lot of the
Speaker 1: success liquidity will go relatively fast in the short period
Speaker 1: of early next year, and then the reduction or balance
Speaker 1: sheet will add to a down draft that will continue
Speaker 1: to draw liquidity structurally out of the markets, and so
Speaker 1: the price for liquidity and the price for investments will
Speaker 1: in my view in the future be quite a bit higher.
Speaker 1: What you saw in the UK was actually because of
Speaker 1: a financial stability concern. The central Bank that was actually
Speaker 1: on course for reducing its balance sheet had to intervene
Speaker 1: in the market and pump liquidity in for three days,
Speaker 1: as Andrew Bailey announced at the IF meeting in Washington,
Speaker 1: d C. In order to stabilize some of the UK
Speaker 1: pension funds that use derivative instruments and therefore got an
Speaker 1: exposure to strong movements in financial markets. So I wouldn't
Speaker 1: be surprised if we have further episodes in the market
Speaker 1: were that combined great increase and withdrawal of liquidity will
Speaker 1: lead to pocket of weaknesses in financial markets because of
Speaker 1: leverage strategies getting cold and not being able to be
Speaker 1: continued as they are. How dangerous is it to have
Speaker 1: quantitative tightening. The shrinking of central bank balance sheets continued,
Speaker 1: and we had traditionally said it was a tool when
Speaker 1: the balance sheet was going out, and it was a
Speaker 1: tool that was less well understood than the impact of
Speaker 1: interest rates. So is it dangerous for central banks to
Speaker 1: keep plowing ahead? I think it's dangerous if they don't
Speaker 1: understand where the leverage is. And so I think we
Speaker 1: will probably see central bank keeping the assets they have.
Speaker 1: By the way, for ten years we haven't seen inflation.
Speaker 1: So the world is designed to have inflation around two
Speaker 1: to three. We had zero for ten years. It's great
Speaker 1: that we're gonna have free four for the next tent.
Speaker 1: It's just simply that you know, when you do an
Speaker 1: average over twenty years, probably the an average is gonna
Speaker 1: end up being about right. Yeah, And hence we need
Speaker 1: some inflation because the only way to deflate that to
Speaker 1: GDP is for inflation. That's always happening in history. One
Speaker 1: of the places you look to think about hidden financial
Speaker 1: stability risks is the i m FS PLAY Financial Stability Report.
Speaker 1: Do you do you agree that we put there are
Speaker 1: potentially some sort of unexploded consequences out there for the
Speaker 1: quantitative tightening in central bank balance sheets. Well, I think, well,
Speaker 1: without a doubt, there are significant segments of the financial
Speaker 1: market that live in the shadows that are not well regulated.
Speaker 1: We call them non bank financial institutions, and that is
Speaker 1: where we are likely to be surprised. And that's what
Speaker 1: happened in the UK. So as our Global Financial Stability
Speaker 1: Report show that when you do a global stress test
Speaker 1: for the banking system, advanced economy banks are quite resilient
Speaker 1: too some very serious downside scenarios. Emerging market banks less so.
Speaker 1: So in a very severe downside scenario, which is in
Speaker 1: the GFSR, we have about thirty percent of emerging markets
Speaker 1: who breach minimum capital requirements. That's a pretty serious event.
Speaker 1: But I think the real unknown is the non bank
Speaker 1: financial system, and that's exactly where we have hidden leverage,
Speaker 1: where we have uh, you know, dark corners, which which
Speaker 1: come up only when things get really difficult, like we
Speaker 1: saw in the UK. So that's something that we are
Speaker 1: worried about. It more generally, in terms of the financial
Speaker 1: conditions at the moment, we see a distinction between you know,
Speaker 1: investment grade assets which everywhere around the world training are
Speaker 1: the spreads are quite low, they you haven't seen much
Speaker 1: movement there, but if you look at frontier markets, that's
Speaker 1: where you're seeing a lot of stress Already. We have
Speaker 1: about sixty of low income countries that are already in
Speaker 1: high debt distress, and I'm about of emerging markets now.
Speaker 1: That does not make a systemic debt crisis for sure,
Speaker 1: but again, we're in very risky times, like the war
Speaker 1: is not over, the pandemic is not over, and we
Speaker 1: haven't won the fight against inflation, so interest rates may
Speaker 1: need to go up much more than any of us
Speaker 1: would like it. Argentina, Scott a lot of debt, a
Speaker 1: lot of it borrowed from the IMF. It has some
Speaker 1: of the highest inflation rates in South America. What's your
Speaker 1: advice to them about how to balance those two? And
Speaker 1: I was just saying that there is no tension between
Speaker 1: what fiscal policy and monetary policy need to do. They're
Speaker 1: all have to go in the exact same direction, which
Speaker 1: is they have to be on the restrictive side. You
Speaker 1: know that part of the I am A program which
Speaker 1: working with the authorities that was green on, which is
Speaker 1: you know what, Argentina, it tanks the economy. Sorry if
Speaker 1: it tanks the economy, then that doesn't support So there's
Speaker 1: one way that we know how to bring inflation down,
Speaker 1: which requires reducing demand in the economy. The Argentina economy
Speaker 1: is growing at a healthy rate, it's there are headwinds
Speaker 1: to it at this moment also from external shocks. But
Speaker 1: you know, having inflation now is over sevent and if
Speaker 1: we want to have durable growth, we know that you
Speaker 1: need to bring inflation down. So just to make a
Speaker 1: point to a dry said, which is inflation helps with
Speaker 1: debt to GDP, clearly not the case on a long
Speaker 1: term basis. Argentina for instance, as an example, where once
Speaker 1: you live in a high inflation environment, that gets priced
Speaker 1: into your interest rates and then there's no gain at
Speaker 1: all in having that kind of inflation. So yes, you
Speaker 1: have a very short term benefits because there's surprise inflation
Speaker 1: and you're you've boarded low rates and you have surprised inflation.
Speaker 1: So you can bring that to GDP down. But from
Speaker 1: the experience, we know that is not a durable way
Speaker 1: to bring that to GDP down and Argentina. Argentina is
Speaker 1: an outlier here. If you look at actually what getas
Speaker 1: job would be in in any of the previous cycles,
Speaker 1: you would have not seen the stability of many of
Speaker 1: the emerging markets that frontloaded some of the interest rate
Speaker 1: increases before the established central banks did in order to
Speaker 1: prevent outflows from their markets into the US and other market.
Speaker 1: Emerging markets have been amazingly resilient so far. But the
Speaker 1: problem is this frontier markets that the weakest and poorest economies,
Speaker 1: because they're facing massive distress. There is a likely rating
Speaker 1: cycle that is going to set in where even those
Speaker 1: that are just about investment grade might get downgrades to
Speaker 1: sub investment grade. The s from rising interest rates on
Speaker 1: these markets, which are the poorest economies of this world.
Speaker 1: It's going to be massive. Are We're gonna be talking
Speaker 1: much more about sovereign debt and developed and developing economies
Speaker 1: next year, having spent the last year really focused on
Speaker 1: monetary policy, not in development market because I think we've
Speaker 1: seen in the UK yours. No, because I think there's
Speaker 1: one advantage currency. Remember, the candacy market is adjusting fast.
Speaker 1: You have seen it in Europe. You know we're paying
Speaker 1: five to six percent for hydro carbon ut gas and
Speaker 1: oil more compared to the United States, and immediately the
Speaker 1: cadency is adjusted in the UK, the panther is adjusted
Speaker 1: fast of the last twenty thirty years. In the gaping productivity,
Speaker 1: I think an image market, and there's a distinction those
Speaker 1: the producer that our food producer are in a good shape.
Speaker 1: The issue here with the war is those that don't
Speaker 1: have enough food that we need to import food, so
Speaker 1: sub Sahanan, Africa, Egypt, the industry Lanca. So if they
Speaker 1: have a problem in the food supply chain with rising
Speaker 1: rates and high level of that, it might end up
Speaker 1: being an absolute catastrophe. And so I think here actually
Speaker 1: where we need to be all worried. Well, I think
Speaker 1: that just alluded to something very important. We're starting to
Speaker 1: see the first round effects of inflation come off, and
Speaker 1: why Central Max have to keep at it is to
Speaker 1: prevent second round inflation very effects and from this to
Speaker 1: become embedded in the wage price mechanism of the economy,
Speaker 1: because once people start believing they should index their contracts
Speaker 1: to four or five percent inflation as opposed to that's
Speaker 1: where it becomes very long lasting and embedded in the economy.
Speaker 1: And that's why in the in the seventies it was
Speaker 1: so hard to get rid of inflation because it had
Speaker 1: become embedded in the economy. We still have the chance
Speaker 1: to prevent that, but it requires determined action that markets
Speaker 1: and market participants will see inflation is going to colm
Speaker 1: down over a reasonable period of time, not the decade.
Speaker 1: I would say two years, three years at the most.
Speaker 1: That helps you anchor inflation expectations. They have not run away,
Speaker 1: so we're not yet lost this inflation battle, but I
Speaker 1: think we need to be really focused on that now
Speaker 1: for the for the period to come, at least for
Speaker 1: the next couple of months. Peter, just a quick response
Speaker 1: to that, So, I mean, do you do you agree
Speaker 1: that we've dealt with the first round, but we still
Speaker 1: need to be very cautious about second round effects. But
Speaker 1: I think also what damadays say, because we've had warnings
Speaker 1: from the European Central Bank just in the last couple
Speaker 1: of days, do you agree that there's not likely to
Speaker 1: be any issues around sovereign debt in the Eurozone in
Speaker 1: the next year or two. So agree with Axcel on
Speaker 1: the fact that it is very important for central banks
Speaker 1: to stay the course. We've had false dawns before. One
Speaker 1: in good inflation reading does not make a trend, and
Speaker 1: we have enough lessons from history of central banks who
Speaker 1: have kind of moved changed course too quickly UH and
Speaker 1: then created an even bigger problem that required grinding the
Speaker 1: economy to hold an even deeper recessions UH than would
Speaker 1: have happened if they had just stayed the course. So
Speaker 1: I think that's absolutely right, and we are there at
Speaker 1: this point that we should this interrom actial state of
Speaker 1: course in terms of sovereign death issues in UH in
Speaker 1: the UR area. Firstly, I think that there have been
Speaker 1: a lot of important developments in the European Union in
Speaker 1: the your area compared to the previous the GFC. You
Speaker 1: have your stability mechanism that is there to help countries
Speaker 1: deal with surprise events or sudden tightening market liquidity. The
Speaker 1: ECB has put in place a transmission protection mechanism, which
Speaker 1: is you know, which is will help them UH raise
Speaker 1: interest rates but ensure that you don't have very disorderly
Speaker 1: market conditions in certain sovereign debt markets. So I think
Speaker 1: that they have more instruments in place, that better mechanisms
Speaker 1: in place to protect themselves to stand run. But but
Speaker 1: there's still question routes about Italy or your Do you
Speaker 1: think we're on the path now where Italy will be
Speaker 1: able to sustain the kind of increase in borrowing costs
Speaker 1: we've seen. I think we're in a time when there
Speaker 1: is a lot of uncertainties. So, like I said, the
Speaker 1: war is not over. We haven't seen the end of
Speaker 1: the energy crisis. This winter is turning out to be
Speaker 1: warmer and that really helps, but the bigger problem is
Speaker 1: next winter. So all of that means that the ability
Speaker 1: to raise resources to repay your death you know, those
Speaker 1: those challenges will remain, uh, you know. At the same time,
Speaker 1: I do think that there's been improvement in policymaking, and
Speaker 1: there's been an improvement in institutions that you help see
Speaker 1: guard against worst outcomes. Petty company as Sarah Banks Favor,
Speaker 1: Thank you, so thank you. That's it for these mini
Speaker 1: episodes from the New Economy Forum in Singapore. Stephanomics will
Speaker 1: be back from London next week. Meantime, check out at
Speaker 1: Economics on Twitter and the Bloomberg News website and terminal
Speaker 1: for all our economic news and analysis. This episode is
Speaker 1: produced by Yang Yang and the executive producer of Stephanomics
Speaker 1: is Mike Sasso.