Visitors take photos of the Grand Teton National Park mountain range from Jackson Lake Lodge ahead of the 2022 Jackson Hole economic symposium. This year’s meeting won’t have many answers, writes Christopher Smart.
About the author: Christopher Smart is managing partner of the Arbroath Group, an investment strategy consultancy, and was a senior economic policy adviser in the Obama administration
With a tantalizing combination of price stability and full employment back in sight, America’s central bankers have chosen to focus on “Structural Shifts in the Global Economy” as they gather for their summer retreat in Jackson Hole, Wyo. next week. But even the distinguished mandarins assembled there won’t have many answers.
The recent bear-steepening in the yield curve shows investors are grappling less with the next interest-rate decision than the far bigger forces that will shape growth and inflation beyond this year: geopolitical confrontation, transformative technologies and extreme weather. Indeed, the best thing the Fed can do to preserve its credibility would be to renounce the “average inflation targeting framework” it unveiled just three years ago at this same gathering and seek insight elsewhere into the shifting dynamics of long-term rates. First, credit where credit is due. We are headed for about as soft a landing as anyone could have imagined when the pandemic hit. Yes, it’s now clear rates should have been hiked earlier given both the rapid deployment of Covid vaccines and what now appears an excessive fiscal package as President Biden arrived in office. But consider the results today. Headline consumer price inflation tumbled from 9% to 3% in just 12 months, and unemployment is still solidly at 50-year lows. Beyond this year, however, rising long-term rates signal doubts that we really understand what lies ahead. At least, they call into question the assumption that the challenge ahead will be to lean against persistent forces of deflation fueled by globalization, technology, and demographics. That idea was behind a Fed policy that now seems questionable. During the lockdown summer of 2020, when virtual conferences were still a novelty, Fed Chair Jerome Powell highlighted falling growth expectations, low interest rates, and tight labor markets that somehow didn’t fuel inflation as they had in most economics textbooks. By targeting average inflation over a loosely-defined period, he argued, the Fed could counteract falling rate expectations that leave a central bank with little room for maneuver in a downturn. The new policy was meant to provide “substantially reduced … uncertainty around economic outcomes,” but in today’s markets it looks more like the crazy relative who lives in the basement that no one wants to acknowledge. The 2020 Statement on Longer-Run Goals and Monetary Strategy, in its official name, argued plausibly that employment, rates, and inflation vary with “economic and financial disturbances.” But consider the structural disturbances that have gained momentum since then. Russia’s invasion of Ukraine, China’s threats against Taiwan, and continuing Middle East turmoil have launched a restocking of national arsenals not seen since the Cold War. Beyond triggering large increases in defense spending that will be hotly debated next February at the annual Munich Security Conference and elsewhere, rising tensions have also justified fresh trade tariffs and forced costly supply chain adjustments. If these geopolitical tensions fuel new inflationary pressures the Fed must now watch, accelerating technological disruptions seem likely to do the opposite. Robotics and automation continue to reduce manufacturing costs, and now looming revolutions in artificial intelligence threaten to destroy jobs across the service sector. How soon and how much remain anyone’s guess, but there are worse ways to watch this space than to see what magic devices are unveiled in January at the Las Vegas Consumer Electronics Conference. Much more difficult to assess will be the macroeconomic pressures from climate change. Carbon pricing, whether explicit or through regulation, will likely fuel inflation and hurt growth. Innovation that delivers cheaper renewable energy will ultimately reduce costs and create new jobs. Experts assembling in the United Arab Emirates for the next U.N. Conference of Parties, known as COP28, in December will sort through these questions. The Fed’s efforts to grapple with long-term rates often focus on the measurement of the natural interest rate, r-star, or the theoretical rate that sustains full employment and stable prices. Some influential Fed modeling suggests that after falling for decades, r-star has not moved much since the pandemic. Other models signal that r-star may be rising, while other sharply amid calls for the Fed to target higher levels of inflation. Today’s headlines suggest an extended battle to drive inflation back to the 2% target. But the truth is that there is more uncertainty than ever around whether the Fed should adopt a structural bias that leans against deflation or tilt fundamentally in a new direction. Powell promised a framework review every five years, but the Fed’s credibility suffers every day it continues to pretend it understands long-term inflation dynamics when the world is changing so fast. The best thing to come from Jackson Hole would be a fond farewell to the 2020 announcement and a commitment that the country’s best monetary economists will start monitoring key conferences elsewhere as they assess accelerating trends in national security, technology on their models. Guest commentaries like this one are written by authors outside the Barron’s and MarketWatch newsroom. They reflect the perspective and opinions of the authors. Submit commentary proposals and other feedback to [email protected].