An inevitable recession ahead?
The first Bureau conversation after the summer break took the form of an economic tour d´horizon. The lead speaker alluded to the discussion before the summer (see the blog entry on ”The spectre of stagflation”), and she pointedly remarked that “nothing has changed fundamentally since then, except for all pressure sensors moving darker into the red”.
Uncertainty about the outlook is unusually high exhibiting prominent downward risks, with inflation running unabated marked by very volatile energy market developments.
Participants generally welcomed the recent move by the ECB to raise policy rates by 0.75 percentage points to tackle record inflation, and further interest rate hikes were seen as very likely to follow soon. However, views diverged on the necessity and urgency of shrinking the ECB bond portfolio of mostly government securities. The ECB´s balance sheet – including assets held by national banks in the eurozone – expanded from € 2.2 tn at the end of 2014 to € 8.8 tn this summer on the back of bond -purchase programmes to tackle low inflation and support the economy during the coronavirus pandemic. Some participants were concerned that maintaining the bond portfolios at its current size could create the risk of an inverted yield curve, easily turning problematic for eurozone banks. Others argued that monetary transmission is still structurally impaired, thus justifying the application of the ECB´s new instrument; indeed, if the ECB reduces the amount of bonds it buys under reinvestments, it is likely to increase long-term borrowing costs (and spreads) for eurozone governments, which have already shot-up close to eight-year highs in recent weeks.
Participants acknowledged that central banks face a difficult task to counter largely supply-side induced inflationary pressures. Some controversy arose over the question whether a recession was inevitable, in fact necessary, to bring inflation down. Gita Gopinath`s remarks at the 2022 Jackson Hole Symposium were referred to as a very-well balanced discussion of the new challenges facing central banks raised by the pandemic and Russia´s war against the Ukraine. While one participant found her stance as overly hawkish, most participants agreed with her policy conclusions, which are in part reproduced below.
“… central banks must act decisively today to ensure that inflation expectations are anchored. We can´t have sustained growth going forward without re-establishing price stability and making sure that our policy framework is well-suited to securing this goal. Forward guidance can play an essential role in communication how central banks will bring this about. Central banks should indicate that they will “stay the course” and maintain tight policy as long as inflation remains high. And if inflation proves unexpectedly persistent, they should underscore their resolve to tighten more aggressively, even if it means a sharp cooling of the economy and rise in unemployment.
While central banks must be in the driver´s seat in the battle against inflation – and have the requisite tools- other policies can help. First, fiscal policy should play a supportive role. While there is a strong case for fiscal policy to help low-income households under current circumstances, such support should be targeted avoid providing macro stimulus. And some countries should likely tighten fiscal policy further. Second, global policy makers need to push ahead on the climate agenda – failing to do so will not only complicate the task of central banks, but will pose grave risks to economic stability and global well-being. Finally, global policies that encourage the expansion of global trade and reduce fragmentation risks will both reduce the risk of volatile supply shocks and help boost potential output around the globe.”