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HSBC Emerging Markets Spotlight Podcast Series - Getting to the Core of Inflation
28 Plays1 year ago
In this episode, one of HSBC’s most senior economists explores the current inflation landscape across the globe, discussing lessons from the past and extending the analysis in his recent book, We Need to Talk About Inflation, to consider whether we are reaching a new monetary policy paradigm.
Emerging Markets Spotlight is a podcast miniseries created and hosted by HSBC that seeks to explore and understand the complex and critically important issues facing the world’s emerging markets. For further insight and information around emerging markets, visit Accessing Emerging Markets | HSBC
Hosted on Acast. See acast.com/privacy for more information.
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Transcript
Introduction to Inflation Discussion
00:00:02
Speaker
Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
00:00:13
Speaker
Make sure you're subscribed to stay up to date with new episodes.
00:00:16
Speaker
Thanks for listening.
00:00:17
Speaker
And now onto today's show.
00:00:24
Speaker
Welcome to HSBC's Global Emerging Markets Forum.
00:00:28
Speaker
My name is Moura Tugan.
00:00:28
Speaker
I'm the Global Head of Emerging Markets Research.
00:00:31
Speaker
I have the pleasure of hosting a very distinguished guest, Stephen King, to talk about inflation.
Introducing Stephen King
00:00:37
Speaker
This panel is about inflation, actually getting into the core of inflation.
00:00:41
Speaker
I know you all know Stephen very well.
00:00:43
Speaker
He doesn't need any introduction, but I'm going to do it anyhow because he's such a distinguished career.
00:00:48
Speaker
So Stephen is HSBC's senior economic advisor and former chief economist, but he's also a very successful author with his latest internationally acclaimed book of We Need to Talk About Inflation, but also previously renowned books such as Grave New World, The End of Globalization, The Return of History, and also When the Money Runs Out.
00:01:07
Speaker
Stephen writes regular columns in the London Evening Standard.
00:01:11
Speaker
and he sits on the Council of Management of the National Institute of Economic and Social Research.
00:01:16
Speaker
Between 2015 and 2017, Stephen was a special advisor to the House of Commons Treasury Committee and his career began at the Treasury where he was an economic advisor within the UK civil service.
What Causes Global Inflation Differences?
00:01:30
Speaker
So, Stephen, let's get right into it.
00:01:32
Speaker
I think we need to talk about inflation.
00:01:33
Speaker
We do, absolutely.
00:01:35
Speaker
And get into the core of inflation.
00:01:36
Speaker
And actually, it's a good place to start with your latest report overnight.
00:01:40
Speaker
And what really strikes me is there's so much talk of global shock on inflation, yet country differences have been completely different.
00:01:48
Speaker
Inflation
Impact of External Shocks on Inflation
00:01:49
Speaker
experiences have been different.
00:01:50
Speaker
Can you walk us through that, please?
00:01:51
Speaker
Thank you.
00:01:53
Speaker
Yeah, I mean, the story, the narrative that most countries have spun about inflation is that it's all to do with external shocks of one kind or another.
00:02:00
Speaker
So it's either the impact of COVID, particularly on supply chains of one sort or another, or it's the impact of Putin's invasion of Ukraine and the knock-on effects feeding through to energy prices and latterly to food prices.
00:02:16
Speaker
The problem with that, though, is that actually the inflation experiences have been completely different depending on where you look.
00:02:22
Speaker
So China, at one extreme, has incredibly low inflation, if not outright deflation on some measures.
00:02:30
Speaker
At the other extreme, you have Argentina and Turkey, you might say the usual suspects when it comes to relatively high inflation.
00:02:38
Speaker
And in the middle, you've got a range of outcomes, which I think...
00:02:42
Speaker
depend more on what's happened with domestic monetary responses to the external shocks rather than the external shocks themselves.
00:02:49
Speaker
So I think this divides into two areas, really.
00:02:52
Speaker
The first area is how countries responded in 2020 in the early stages of the pandemic.
00:02:58
Speaker
Now, bear in mind that at that time, you had what appeared to be catastrophic declines in GDP on a scale similar to what we'd seen during the Great Depression of the 1930s.
00:03:10
Speaker
We know in hindsight that, you know, a big chunk of that collapse was all to do with lockdowns.
00:03:14
Speaker
And of course, the lockdowns varied in intensity depending on the degree to which the disease was spreading and the published mortality rate.
00:03:23
Speaker
So
Monetary Responses to Inflation
00:03:24
Speaker
during the course of 2020, China seemed to be on top of things, whereas the West increasingly appeared not to be on top of things.
00:03:31
Speaker
The lockdowns in the West became ever more draconian, even as China appeared to be unlocking.
00:03:37
Speaker
And the consequence of that was that China offered very little in the way of monetary and fiscal stimulus, whereas the Western developed world offered vast amounts of monetary and fiscal stimulus.
00:03:48
Speaker
So arguably, it was the West that sort of created conditions that turned out to be inflationary subsequently.
00:03:55
Speaker
And then when the lockdowns came to an end, demand recovered in the West, in some cases, more strongly than had been anticipated because there were tremendous financial asset gains in the intervening period because supply conditions did not return to where they had been pre-pandemic.
00:04:09
Speaker
What you effectively ended up with was an excess of demand oversupply, which led to a series of pretty big upside surprises to inflation through the course of 2021 and beyond.
00:04:19
Speaker
And so I think the initial reason for the differences in inflation was associated with the policy responses way back in 2020.
00:04:29
Speaker
We move to a second stage, which is that countries that saw inflation picking up responded differently to the threat.
00:04:37
Speaker
Some, scarred by past inflation that had been incredibly high, actually responded with incredible aggression.
00:04:43
Speaker
And Brazil is an extremely good example of this, where nominal rates go up a long way and real policy rates go into very, very dramatic, positive, real territory.
00:04:54
Speaker
So you've got this tremendous tightening coming through Brazil.
00:04:56
Speaker
which I think was a legacy in one sense of recent Brazilian problems, if I can put it that way, with inflation.
00:05:02
Speaker
The US abolishes the word transitory by the end of 2021, recognises inflation is more clearly established, raises rates much more aggressively than expected in 2022, and indicates for the most part that although rates are going up, they had further to rise.
00:05:18
Speaker
So there was a kind of bias towards tightening throughout this entire period.
00:05:22
Speaker
Whereas the Eurozone and the UK were much more focused, I think, on the growth consequences of higher energy prices rather than the inflationary consequences.
00:05:28
Speaker
And in fact, in those two cases, there was tremendous caution.
00:05:32
Speaker
Interfix did go up eventually, but slowly compared with the US and very slowly compared with the Brazilians,
00:05:39
Speaker
And I think the consequence of this was that Europe and the UK ended up with more in the way we might describe a second round effect.
00:05:45
Speaker
So effectively, wage increases, price increases coming through that stem not from the initial cost shock from elsewhere in the world, but from the absence of sufficient monetary tightening.
Monetary Policy and Public Perception
00:05:56
Speaker
And what is striking, actually, when you look at the Eurozone in the UK, that you find that even now, real policy rates measured by either headline and core inflation are still negative, whereas they're positive elsewhere.
00:06:07
Speaker
The way I tried to account for this in the piece, which is called tackling inflation, was to suggest there's a sort of comparison with a football referee or at least two football referees.
00:06:17
Speaker
Imagine one football or soccer referee that is very keen to issue lots of yellow and red cards, another one who never ever issues yellow and red cards.
00:06:26
Speaker
My contention is that the players faced with the first referee behave very differently
00:06:31
Speaker
compared with the players faced with the second referee.
00:06:34
Speaker
In other words, with the first referee, when there's lots of yellow and red cards threatened to be issued, there are very few fouls.
00:06:40
Speaker
Whereas with the second referee, there are lots of fouls because this referee seemed to be a sort of soft, soft referee, not serious about tackling fouls.
00:06:49
Speaker
behavior on the pitch.
00:06:50
Speaker
And much the same thing is true of monetary policy, that if you're faced with an inflationary shock, and you dismiss it and say, look, it's not important, it will go away.
00:06:58
Speaker
And it turns out you're a forecast for inflation are wrong, the public become restless, they begin to think, well, actually, you're not on top of it.
00:07:05
Speaker
If you're not on top of it, why should we believe your inflation forecast?
00:07:07
Speaker
And if we don't believe your inflation forecast, what's happened to your credibility?
00:07:11
Speaker
If your credibility is being damaged, then I'm actually I will demand a bigger pay increase because
00:07:16
Speaker
I no longer believe you can actually achieve the inflation target you're supposed to be achieving.
00:07:20
Speaker
So I think the public reaction to the referee, if you like, is a very important part of the inflation process.
00:07:27
Speaker
And I think it's being dismissed too quickly by sort of conventional thinking about how inflation rises.
00:07:33
Speaker
Thank you, Stephen.
00:07:34
Speaker
That actually sets the stage very nicely.
00:07:36
Speaker
But you mentioned also in your report that inflation has come down a long way globally, but yet you've got core inflation still elevated and sticky.
00:07:44
Speaker
And actually we've looked in the history, it's relatively rare episodes where actually you have core inflation higher than headline, where usually it's the other way around and the temporary shocks, they fade away and core approaches headline.
00:07:55
Speaker
But this time we have core much higher.
00:07:57
Speaker
So it's still very tricky.
00:07:59
Speaker
We shouldn't sort of, you know, declare victory over inflation or combating inflation.
00:08:04
Speaker
How do you see the backdrop from here with elevated core?
00:08:06
Speaker
Well,
Globalization's Impact on Inflation
00:08:07
Speaker
I think there's an OECD report that came out just today, which is talking about the fact that the inflation numbers have improved, but they haven't improved fast enough.
00:08:14
Speaker
And there should be a continuous bias towards relatively high interest rates.
00:08:20
Speaker
I think another way of putting this is as follows, that we went into COVID after 10, maybe 20 years of disinflation and deflation.
00:08:29
Speaker
And we got into it after a period when interest rates themselves had collapsed to zero, when there was a long discussion about the dangers of inflation.
00:08:39
Speaker
zero rates and the possibility of a sort of negative feedback loop with regard to rising real rates against the background of deflationary problems.
00:08:48
Speaker
And people looked at Japan and thought, well, this is a lead indicator of what might happen elsewhere in the world.
00:08:54
Speaker
But when you look at the long run history of both inflation and interest rates, the period prior to the pandemic was incredibly unusual, both in terms of the absence of inflation, but also these ridiculously low interest rates.
00:09:06
Speaker
And I think a lot of people are hoping that we will return to that period as if that period itself is normal.
00:09:12
Speaker
I don't think it is.
00:09:13
Speaker
I think that period was highly abnormal.
00:09:15
Speaker
And we're now beginning to see some of that beginning to reverse.
00:09:18
Speaker
So why is it reversing?
00:09:20
Speaker
Well, part of it actually is to do with globalization.
00:09:21
Speaker
This goes back to my earlier book, Brave New World, namely that globalization was already, I think,
00:09:29
Speaker
I wouldn't say it was in trouble, but it was certainly facing difficulties and hurdles long before the pandemic.
00:09:35
Speaker
Obviously, relations between Beijing and Washington had deteriorated.
00:09:38
Speaker
This actually predates Donald Trump coming in in 2016.
00:09:42
Speaker
Congress in particular had become increasingly worried about its relationship with China.
00:09:49
Speaker
And the consequence was that the kind of great sort of hyper-globalization story where borders and barriers just fall
00:09:56
Speaker
tumble away and disappear when you move towards one big global economy, that was already beginning to change.
00:10:01
Speaker
The borders and barriers were subtly, in some cases, beginning to be rebuilt.
00:10:06
Speaker
Same was true, of course, in Europe with Brexit, which is an example of rebuilding borders and barriers that weren't there previously.
00:10:12
Speaker
You might equally say it's true of the rise of populism, that populism often is associated with the narrative of nationalism.
00:10:19
Speaker
All these things were happening prior to the pandemic.
00:10:21
Speaker
The pandemic sort of turbocharges a lot of this, and maybe only temporarily, because there's a sudden focus on national resilience and shortening supply chains and so on and so forth.
00:10:32
Speaker
And some of that undoubtedly will fade over the next few years.
00:10:35
Speaker
But nevertheless, I would suggest that the period of hyperglobalization, which created what you might call a deflationary tailwind,
00:10:43
Speaker
particularly for the Western developed world, that was already going into reverse.
00:10:47
Speaker
So I think you are seeing a shift from a deflationary tailwind to an inflationary headwind, which is another way of saying that for any given growth rate in the Western developed world, you are likely to find that inflation will be higher for that given growth rate or put it upside down for any given inflation rate.
00:11:04
Speaker
You may have to have a lower growth rate than was true previously.
00:11:07
Speaker
So effectively, the trade-off between growth and inflation
00:11:10
Speaker
has deteriorated because globalization itself has shifted gear and possibly gone in a different direction.
00:11:16
Speaker
Thank you, Stephen.
00:11:17
Speaker
Does the Fed need to carry on showing red cards and keep rates higher for longer?
00:11:23
Speaker
I think the answer is probably yes.
00:11:25
Speaker
I mean, not so much raising rates much further from where we are currently, because as I said before, if you think about real policy rates, they are now in positive territory.
00:11:35
Speaker
And I've often thought that if you want to show that monetary policy is appropriately tough, it's not measuring policy rates on the basis of forward inflation, because you kind of assume you answered your question on that basis, but it's tough in terms of looking at policy rates compared with current inflation.
00:11:51
Speaker
And in that sense, the Fed is in a position which is different from, say, the Bank of England or the European Central Bank.
00:11:56
Speaker
But having said that, it is still true that the labor market is relatively tight, notwithstanding the increase we've seen in unemployment in recent times.
00:12:03
Speaker
It is true that headline inflation last month went up rather than coming down.
00:12:08
Speaker
It's true that globally we have oil prices shooting back up again, having fallen back over the course of the last year or two.
00:12:15
Speaker
And I would suggest that on the balance of risks at the moment,
00:12:19
Speaker
If I were the Federal Reserve, I'd be more worried about inflation re-accelerating rather than the sudden shift towards a recession.
00:12:26
Speaker
Or put another way, if you're being really extreme about this, I might say I prefer risking recession rather than risking inflation.
00:12:35
Speaker
And the reason why you might say that actually is a lesson from the 1970s and 1980s, which is that back in the 1970s, Arthur F. Burns
00:12:42
Speaker
who was the chair of the Fed at the time, admitted after he stepped down from the Fed that the Fed was always too quick to cut interest rates before inflation had been properly dealt with, before inflation had really been tackled.
00:12:57
Speaker
And the problem was that the economy was slowing down.
00:12:59
Speaker
There were some temporary signs of weakness.
00:13:01
Speaker
They cut rates prematurely.
00:13:03
Speaker
This would lead to a ratcheting up of inflation into the future.
00:13:07
Speaker
So I think all these hopes are suggesting that rates have peaked and they're going to come down swiftly.
00:13:12
Speaker
If I'm in the Federal Reserve currently, I'm thinking I don't want to do that because if I do that, then I'm actually risking undoing, unpicking all the good work I've done in tackling inflation so far.
00:13:24
Speaker
Another way of putting this is going back to the sort of globalization headwinds and tailwind story is to say, actually, the tradeoff is worse than it was.
00:13:32
Speaker
Inflation is more of a challenge than it was.
00:13:34
Speaker
And therefore you do require almost like a permanently tougher set of monetary conditions that we endured, that we lived through in this very peculiar deflationary world that was a characteristic of the decade before the onset of COVID.
00:13:49
Speaker
What can we
UK's Unique Inflation Challenges
00:13:50
Speaker
expect from Bank of England after today's announcement that UK inflation falls to 6.7, obviously a big fall in core inflation, but maybe you can also tie it to what you think about UK's own inflation in terms of some unique shocks like Brexit and the measurement issues, et cetera.
00:14:03
Speaker
Sure.
00:14:04
Speaker
So first of all,
00:14:07
Speaker
I'm going to give you a little anecdote, a little story from the 1980s, from the late 1980s, because my career started in the Treasury in the late 1980s or the mid 1980s.
00:14:16
Speaker
And just before I left the Treasury, there was a big discussion about whether inflation is finally being conquered.
00:14:21
Speaker
And at the time, headline inflation had dropped to about three and a half percent, which by UK standards at the time was very, very low.
00:14:29
Speaker
But wage inflation was still running at about 7.5% or 8%.
00:14:33
Speaker
So you had some people saying inflation is dead and wage growth will slow down in line with this lower headline inflation rate.
00:14:41
Speaker
And others are saying, no, no, the fall in the headline inflation rates do with falling oil prices are temporary.
00:14:47
Speaker
We should be much more worried about the underlying inflation conditions are set by wage growth.
00:14:51
Speaker
In hindsight, the people who are worrying about wage growth were the ones who were right.
00:14:57
Speaker
The ones who were seizing upon the drop in headline inflation were the ones that were wrong.
00:15:01
Speaker
And it all sort of culminated in what became known in hindsight as the Lawson boom.
00:15:06
Speaker
So as far as the UK is concerned, the difference in one sense is that if you compare the UK with the US Bank of England, the Federal Reserve,
00:15:13
Speaker
Jay Powell abolishes the word transit train around October, November of 2021.
00:15:17
Speaker
He admits very, very early on that the inflationary momentum is actually quite significant and requires considerable policy action.
00:15:26
Speaker
The Bank of England, the Monetary Policy Committee there,
00:15:29
Speaker
is still trying to push the line that the rise in inflation is temporary.
00:15:33
Speaker
It's all to do with external shocks of one kind or another, that the central bank is credible, and therefore there's very little likelihood of second round effects.
00:15:41
Speaker
So the idea is that what goes up comes down, that gravity reasserts itself, and that we're still in the world of price stability.
00:15:47
Speaker
Fast forward to, I suppose, the spring or early summer of this year, 2023, Bank of England finally admits that its models of inflation haven't worked very well.
00:15:57
Speaker
They finally admit that second round effects have proved to be bigger than they had anticipated.
00:16:01
Speaker
Now, it may be the case.
00:16:03
Speaker
that the higher wage increases in the UK compared with elsewhere are a reflection of a reduction in, if you like, migrant labour supply or the elasticity of migrant labour supply linked to Brexit.
00:16:14
Speaker
That is a possible factor.
00:16:17
Speaker
But the other factor, it goes back to this idea that monetary policy wasn't tightened
00:16:22
Speaker
soon enough.
00:16:22
Speaker
In fact, the gap that opens up between Fed funds and the Bank of England policy rate gets pretty big through the course of 2022, suggesting the bank is a laggard compared with the Federal Reserve.
00:16:32
Speaker
And that also, in my view, explains some of the differences coming through in terms of inflation.
00:16:36
Speaker
But another way of putting this is that UK wage inflation today is currently running about 8%, which is way higher than it was pre-COVID.
00:16:45
Speaker
Pre-COVID is running about 2% and had been doing so for year after year after year.
00:16:49
Speaker
So it's quadrupled in terms of its growth rate.
00:16:52
Speaker
It is true that the headline inflation rate, the core inflation rate today have come in lower than expected, all of which is very welcome news.
00:16:59
Speaker
And it may temper the extent to which the bank raises rates any further in the short term.
00:17:04
Speaker
If I were on the NPC, I'd be looking at the wage numbers and thinking, this isn't right, that this is a sign of embedded underlying inflation.
00:17:14
Speaker
It's going to require quite a lot of work to remove it.
00:17:17
Speaker
The key thing here, and this is something I sort of focused on in the book, when you talk about inflation, is that inflation is not just a technocratic problem for central banks.
00:17:26
Speaker
It is a fundamental political economy problem because once it's established,
00:17:31
Speaker
Because of the way in which contracts overlap and some people get a pay increase this month and some people get a pay increase six months' time, a year's time, whatever it might be, you're always, when inflation is established, leaving some people behind.
00:17:43
Speaker
But the people who are left behind, quite rightly say, it is unfair that they should not get the inflationary pay increase that others have already had.
00:17:50
Speaker
And so once you've established that sort of going rate mentality, then puncturing that, A, is more difficult and probably requires more in the way of economic pain.
00:18:00
Speaker
And no one wants economic pain.
00:18:01
Speaker
So the easiest thing to do in the short run is to pretend that the inflation is temporary or simply go away.
00:18:05
Speaker
But once you've established it's embedded, then unfortunately, costs of getting rid of it at that stage become that much greater.
00:18:12
Speaker
And so I think what is interesting about the debate currently is a sort of binary debate.
00:18:16
Speaker
Is it going to be recession or is it going to be inflation?
00:18:19
Speaker
As if the two are exclusive.
00:18:21
Speaker
But I don't think they necessarily are.
00:18:23
Speaker
Once you've got inflation established, you may find, as we saw in the 1970s, that you're stuck with
00:18:29
Speaker
growth underperforming where you'd like it to be and inflation being too high.
00:18:33
Speaker
Which is another way of saying that the output gap as a sort of concept is incredibly unstable in predicting where inflation might be from one cycle through to the next.
00:18:43
Speaker
Thank you, Stephen.
00:18:44
Speaker
Now, obviously, we talked about the US, the Fed, Eurozone, the UK.
00:18:49
Speaker
But can we actually do a bit of a deep dive on Japan?
00:18:52
Speaker
Clearly,
Japan's Inflationary Landscape
00:18:53
Speaker
the only country out there with negative policy rates.
00:18:56
Speaker
But, you know, I wonder what would happen if Japan's inflation follows a similar pattern like in the US and Europe and what sort of policy levers do they have in such an environment?
00:19:07
Speaker
Well, Japan, I think, is what I describe as a proper sort of intellectual challenge because it is faced with the
00:19:15
Speaker
sort of extraordinary tension in one sense, because let's face it, Japan is a sort of the cheerleader for all things deflationary.
00:19:23
Speaker
Deflation kicks in in the early 1990s, been stuck with Japan ever since.
00:19:29
Speaker
And it's quite difficult to get yourself out of the mindset that deflation is a sort of natural order of things in Japan, you know, aging population, high levels of government debt, etc, etc.
00:19:37
Speaker
Isn't that all associated with deflation?
00:19:39
Speaker
But it is odd that
00:19:40
Speaker
But over the course of the last few quarters, inflation has risen.
00:19:45
Speaker
It's the highest it's been in decades.
00:19:48
Speaker
So it's not that high by other countries' standards, but by Japanese standards, it's the highest it's been in decades.
00:19:54
Speaker
It is much higher than is true of China.
00:19:56
Speaker
So if you compare those two as sort of
00:20:00
Speaker
There's a very big difference in terms of the at least the measured inflation numbers.
00:20:05
Speaker
I think if you're the BOJ, you're very much hoping this inflation is entirely transitory, it'll fall away again.
00:20:11
Speaker
And the reason why you're hoping that is that let's imagine that inflation does become more established, that inflation like in, say, the UK or the Eurozone sticks around at higher rates for a lot longer than people expect.
00:20:22
Speaker
Maybe for the first year or so, it doesn't feed through to wage negotiations, but you can pretty much bet that year two or year three, it begins to feed through into people's wage settlements.
00:20:33
Speaker
And then inflation is more clearly established.
00:20:35
Speaker
The problem then is that you might then need to raise interest rates belatedly to deal with what is now a more persistent inflation threat.
00:20:44
Speaker
And if you go back to my earlier comment that it helps when real policy rates are into positive territory, well, that's great from the point of view of dealing with inflation.
00:20:53
Speaker
But if you have a whopping great big government debt as a share of GDP, and you're suddenly moving from negative rural rates or whatever to significantly positive rural rates, the fiscal situation suddenly begins to look a little more unstable.
00:21:10
Speaker
And I wonder in those circumstances,
00:21:13
Speaker
what sort of tension would come through, because to resolve the tension, I guess, you're either faced with trying to deal with the inflation, which might mean higher real rates and a very unstable fiscal path, which is not very good, or instead you want to avoid the unstable fiscal path, in which case you accommodate more in the way of inflation into the future.
00:21:28
Speaker
And it would be very odd in one sense, quite ironic in one sense, that the one country that's had the most deflation becomes the one that accommodates the most inflation in the future because of the vulnerability of their fiscal position.
00:21:40
Speaker
And it is worth stressing that the relationship between monetary and fiscal policy, which many people assume to be non-existent,
00:21:48
Speaker
is one that is, it reoccurs, it reoccurs because at some point, the fiscal position of a country becomes so unstable, that rather than defaulting, it's easier to create inflation, because effectively inflation benefits you as the government debtor, even though it penalises the private saver who's invested with that particular government.
00:22:07
Speaker
So throughout history, whether it's coin clipping, or currency debasement, or whatever it is,
00:22:14
Speaker
monarchs, kings, queens, parliaments, governments have often resorted to inflation when all the other choices are even more unattractive.
00:22:24
Speaker
So it's the best of a bunch of bad options to allow inflation to come back.
00:22:28
Speaker
And I don't think it's entirely impossible that these kinds of choices could be faced in the years ahead.
00:22:35
Speaker
Fascinating.
00:22:37
Speaker
Thank you, Stephen.
00:22:38
Speaker
The next question reminds me of your book.
00:22:40
Speaker
And the question essentially
Paradigm Shift in Monetary Policy
00:22:41
Speaker
says, are we in a paradigm shift when it comes to inflation monetary policy?
00:22:45
Speaker
What to expect going forward?
00:22:47
Speaker
So I think we may be in a kind of paradigm shift.
00:22:52
Speaker
And what I mean by that is that
00:22:55
Speaker
We've had decades of central banks having a relatively easy life.
00:23:00
Speaker
The inflation has been low and stable.
00:23:02
Speaker
There have been occasional shocks here and there in terms of headline inflation, but there's been very little effect on core inflation.
00:23:09
Speaker
There's been no cumulative shocks of one kind or another that might sort of really upset the apple cart.
00:23:15
Speaker
That's all changed over the course of the last three or four years.
00:23:18
Speaker
But it's not just a change in terms of external shocks.
00:23:21
Speaker
It is also, I would suggest, a change in terms of institutional arrangements and possibly in terms of central bank complacency.
00:23:29
Speaker
So on the institutional arrangements, take our minds back to where we were pre-COVID.
00:23:33
Speaker
You'd had a number of years where the only worry that central bankers are faced with in terms of the macro inflation story was deflation rather than inflation.
00:23:44
Speaker
And I think that led to some institutional changes, which meant that it was more difficult to cope with inflation when it finally returned.
00:23:52
Speaker
One of those is, I suppose, the discussion about things like flexible average inflation targets, the idea that you'd pre-commit to having higher inflation in the past to deal with inflationary undershoots in the past, this commitment to being irresponsible.
00:24:07
Speaker
Well, that's fine if you're living in a world of generally deflationary pressures.
00:24:12
Speaker
But if you're living in a world of inflationary pressures, you basically respond too little too late to the pickup of inflation because at first you're giving a message that you want this higher inflation.
00:24:23
Speaker
Only in hindsight do you realize it's the wrong kind of higher inflation and you have to do something about it.
00:24:28
Speaker
The other institutional change actually is associated with QE.
00:24:31
Speaker
Now, I recognize that QE ended quite some time ago.
00:24:35
Speaker
But the fact that QE did exist and the fact that a lot of people expect it to exist in the future, if there's another recession, interest rates drop to zero, then QE presumably comes back on stream.
00:24:46
Speaker
actually has created, I think, difficulties in the behavior of government bond markets.
00:24:49
Speaker
And here, the problem, I think, is the sort of gradual watering down of the pressures from bond market vigilantes.
00:24:56
Speaker
And what I mean by that is that in the past, when inflationary pressures built, bond yields would rise very quickly.
00:25:01
Speaker
It was an early warning signal to central banks that they had to act quickly to make sure that inflation expectations remain well-behaved.
00:25:09
Speaker
If the central bank, through QE, is effectively the buyer of last resort for all government debt,
00:25:14
Speaker
then actually that early warning system breaks down.
00:25:16
Speaker
You haven't got the radar telling you that inflation is about to return.
00:25:20
Speaker
And therefore, you're dismissive for far too long.
00:25:22
Speaker
And once it has returned in a kind of political sense, it then becomes much more difficult to get rid of it.
00:25:27
Speaker
So that's one change.
00:25:28
Speaker
The second change, I think, is the fact that money supply growth was ignored.
00:25:33
Speaker
I mean, it's come back into fashion a bit recently over the last year or two.
00:25:37
Speaker
But I think it's fair to say that most central banks were entirely dismissive
00:25:41
Speaker
because it hadn't been a good predictor for the previous 30 years.
00:25:44
Speaker
But that was 30 years of relatively well-behaved money supply growth, whereas what we've seen recently has been completely off the charts.
00:25:50
Speaker
So that, I think, was a mistake, and it reveals an error at the heart of monetary policymaking, which I think is partly institutionalised.
00:25:57
Speaker
For example, look at the Monetary Policy Committee of the Bank of England and ask the question, how many of the people on the MPC are genuine experts
00:26:05
Speaker
in the monetary economy, in thinking about the relationship between monetary aggregates and the broader economy.
00:26:12
Speaker
And the answer is, I reckon, very few of them are, if any, because they're mostly focused on output gaps and dynamics, dynamic, stochastic, general equilibrium models and so on, that really have no role for money at all.
00:26:23
Speaker
So there's a kind of institutionalized bias that doesn't deal with those kinds of things.
00:26:27
Speaker
And I'd also add,
00:26:29
Speaker
that there's an element of complacency that we've moved from money supply targeting, exchange rate targeting through to Taylor rules.
00:26:37
Speaker
And then we get to kind of forecast targeting rules, which most central banks have used recently.
00:26:43
Speaker
But they're entirely circular.
00:26:44
Speaker
Effectively, what the central bank says is, so long as we act credibly, the public continue to believe that we're credible, that inflation is likely to settle down at 2%.
00:26:53
Speaker
But that assumes the answer to your question, that the public continue to believe you're credible.
00:26:58
Speaker
What you don't ask is the question, what happens if the public begins to have doubts?
00:27:03
Speaker
Once they have doubts, then there's a serious risk that inflation comes in higher than you'd like it to be.
00:27:09
Speaker
So my fear is that we may find, partly because we've lost track of the importance or the dangers of inflation,
00:27:18
Speaker
that we've become more accommodating of it.
00:27:21
Speaker
And in fact, you could even say that intellectually this is beginning to happen because there weren't many calls for lowering inflation targets when inflation was below 2%, but it's remarkable how many calls there are now for raising inflation targets when inflation is above 2%.
00:27:34
Speaker
So there's a kind of almost like an intellectual bias in terms of the risks associated with all this.
00:27:40
Speaker
So you've got people like Olivier Blanchard asking for a higher inflation target.
00:27:44
Speaker
You had Jason Furman writing a similar article in the Wall Street Journal the other day.
00:27:49
Speaker
Andy Haldane, former Chief of Commerce Banking, actually argued earlier this year that inflation targeting should be temporarily postponed or lifted until global supply conditions had re-equilibrated and then would simply reimpose the inflation targets as if by that stage they'd have any credibility whatsoever.
00:28:07
Speaker
So I think part of the issue here is inflation has overshot and people are so fearful of squeezing out of the system that they're instead beginning to say, well, maybe we should just tolerate a bit more inflation.
00:28:18
Speaker
But when you're doing that, when inflation is already higher than target, it begins to make it look as though you're saying maybe you should simply live in the world of higher inflation than being used to over the last 20 or 30 years.
00:28:27
Speaker
So in that sense, it becomes an institutionalized shift in the mindset.
00:28:33
Speaker
Thank you, Stephen.
00:28:34
Speaker
And perhaps we bring this back to emerging markets.
Emerging Markets and Policy Risks
00:28:36
Speaker
EM Center banks have already started cutting rates aggressively.
00:28:39
Speaker
Well, at least some are doing it.
00:28:40
Speaker
Are they on the brink of a policy mistake?
00:28:42
Speaker
What do you think?
00:28:44
Speaker
Well, you partly come back to where we are on real rates.
00:28:48
Speaker
So let's take Brazil as the sort of poster child for aggressive tightening.
00:28:53
Speaker
It has cut rates.
00:28:55
Speaker
but it's cutting rates when real rates are incredibly high.
00:28:58
Speaker
And you might say that there is a bit more room for them to do so.
00:29:01
Speaker
It's partly a case-by-case basis, isn't it?
00:29:03
Speaker
I mean, you know, if you've got a country which is cutting rates and it has a healthy balance of payments position and inflation has come down and appears to be
00:29:12
Speaker
falling further, then you might say it's perfectly reasonable.
00:29:15
Speaker
If you've got a country where the inflation numbers are coming down, but you've got a big balance of payments deficit or whatever, and you're cutting rates because you think you can just about get away with it.
00:29:24
Speaker
Well, if everyone else has got relatively high rates, you might find that the currency is under pressure.
00:29:28
Speaker
The currency being under pressure eventually leads to inflation rising again.
00:29:32
Speaker
Actually, there is a, this is not an emerging market story at all, but it is part of the story in Japan.
00:29:38
Speaker
We discussed it earlier on that one reason why Japanese inflation has been higher than people thought is that because the BOJ is stuck with these very low rates when everyone else is at high rates, the Japanese yen, of course, has weakened.
00:29:49
Speaker
And as it's weakened, it's probably contributed to higher domestic inflation that would otherwise be there.
00:29:54
Speaker
In other words, the risk is that if you cut rates when everyone else is still raising them, then your exchange rate is in danger of coming under downward pressure.
00:30:03
Speaker
If it comes under downward pressure, then what you're kind of doing is redistributing inflationary pressures from one part of the world to another part of the world.
00:30:10
Speaker
So I think the key thing here is that
00:30:13
Speaker
Any policy market has to be conscious, not just of what's happening in terms of domestic economic conditions, but the extent to which opportunities are created from developments elsewhere in the world that allow you the space to deliver these kinds of policies.
00:30:26
Speaker
So even if you think you deserve it, it might still be a worrisome thing to do if it turns out that the Fed or others are keeping rates higher for a longer period of time.
00:30:37
Speaker
So if you look at your crystal ball and a peek into 2024,
00:30:42
Speaker
Where do you think victory could be declared over inflation?
00:30:45
Speaker
Where
Conclusion: Inflation Risks and Adaptation
00:30:46
Speaker
can we open up champagne bottles?
00:30:48
Speaker
And where do you think there will be continued issues and problems?
00:30:52
Speaker
Well, as you know, I don't do forecasts anymore, so I can happily sidestep that question.
00:30:56
Speaker
But I suppose at the moment, in terms of inflation stickiness, you'd be more worried about the UK, Eurozone and other parts of Europe than elsewhere, because the inflation definitely is more sticky in those parts of the world.
00:31:10
Speaker
For the US, I think I would like to see a greater softening of the economy than we've seen so far.
00:31:15
Speaker
Not because I want to see the economy softening, but because I'm worried that in the absence of such softening, inflationary pressures may simply rebuild.
00:31:22
Speaker
So that's bothersome.
00:31:24
Speaker
And as far as emerging markets are concerned, there's a whole range of different emerging markets.
00:31:28
Speaker
The idea that emerging markets are all in one bucket, they all behave in exactly the same way, that's no longer true, not even true within, say, Latin America.
00:31:36
Speaker
So I think it's important to recognise
00:31:38
Speaker
First of all, how credible has the central bank's reaction been?
00:31:42
Speaker
How institutionally independent is it?
00:31:44
Speaker
And how likely is it that you can deliver what it wants to deliver in terms of defeating inflation?
00:31:50
Speaker
How vulnerable is the currency, particularly in terms of negative terms of trade shocks of one kind or another?
00:31:57
Speaker
All these things matter.
00:31:59
Speaker
So I think that for EM, well, my recommendation would be for people to listen to Murat because you're the expert.
00:32:06
Speaker
That's very kind of you, Stephen.
00:32:08
Speaker
That was a fascinating discussion.
00:32:09
Speaker
I totally enjoyed it.
00:32:11
Speaker
I've taken lots of notes.
00:32:12
Speaker
Thank you so very, very much for being with us.
00:32:15
Speaker
And yeah, please keep talking about inflation.
00:32:17
Speaker
Thank you, Stephen.
00:32:18
Speaker
And thanks, everyone.
00:32:19
Speaker
Thank you.
00:32:20
Speaker
Thank you for joining us at HSBC Global Viewpoint.
00:32:24
Speaker
We hope you enjoyed the discussion.
00:32:26
Speaker
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