By Luke Bartholomew
Things have moved on a lot since Jackson Hole started out as a small conference about agricultural economics. It’s now a major gathering of the great and good of central banking where some big policy decisions have been announced in recent years. The (slightly dry sounding) topic for this year is “Designing resilient monetary policy frameworks for the future”. It’s a opportune moment for the Fed to reflect on what it will do in the years to come.
The economic data is volatile but the US has recovered from the financial crisis to all intent and purpose. Unemployment is low and wages are starting to increase. So the Fed has largely achieved its objectives. But it’s taken a lot of effort. And the fact that very low interest rates have been required for a very long time points to longer term issues the Fed is now turning their attention towards.
The problem can be framed around the secular stagnation debate. It’s a relatively amorphous concept that different people interpret in different ways. But, broadly speaking, the idea is there have been deep, structural changes to the economy. And these mean that the economy’s potential growth rate will be much lower in the future (the supply version), or that the economy will struggle to grow in line with its potential, whatever that potential is (the demand side version).
The implications of each form of secular stagnation are subtly different. But both types will mean that the interest rate that we would consider ‘normal’ will be lower in the future than it has been in the past. The Fed has now come to the conclusion that this normal rate, or the equilibrium rate, will indeed be lower than it has been in the past. Which is a tacit admittance that the US is in the midst of some sort of secular stagnation.
President of the San Francisco Fed John Williams has just published an essay that helps move the debate on from whether secular stagnation is happening to what to do about it.
Firstly he argues that fiscal policy should be used as a way of stabilising demand more. It is generally neglected as a tool for managing demand because some (mistakenly) worry about “fiscal sustainability”, and the pre-crisis consensus that on the whole monetary policy is a better tool. But fiscal policy will have to do some of what monetary policy cannot in a world of permanently lower interest rates.
Secondly, he argues that the Fed should have a higher inflation target. Higher inflation expectations would push up the equilibrium interest rate. This would also mean that the Fed’s own policy rate would be higher and give them more room to cut when necessary.
Finally he suggests changing how inflation targeting works. Under his thesis the Fed would set its policy to try and achieve a constant, steady growth rate over the long run. They would do this by setting their policy in the future to compensate for whether growth has been above or below trend in the past. It would make the Fed more accommodative in a recession and should make monetary policy easier to conduct through the economic cycle even if the equilibrium rate is permanently low.
None of Williams’s prescriptions are new, particularly radical or going to be adopted any time soon. But these are some of the topics that will be discussed at Jackson Hole. As such, these are the topics that serious Fed policy makers want to talk about and think are important. That makes them important for investors. They are also sensible. Williams is right that fiscal policy should have more of a role to play. Central bankers, investors and pretty much everyone apart from the politicians in charge of fiscal policy have been saying as much for years. Over reliance on monetary policy has produced a disappointingly slow recovery across advanced economies.
Jackson Hole might not reveal when the next hike is coming but it will help guide investors’ understanding about what the Fed will do over the next decade and beyond.
Luke Bartholomew is an investment manager at Aberdeen Asset Management
