Central banks: pivoting or wimping out?

Yes, as early as May 2020, Nouriel Roubini, Dr. Doom to both fans and detractors, in one of the Odd Lots podcasts, had already warned that any economic recovery from the pandemic would be, as Bloomberg described it, “followed by a period of high inflation owing to a combination of supply shocks and aggressive easing.”

Today, he is predicting that central banks, seeing both the market and economic pains caused by the huge interest rate increases, might reverse course, pivot to some, and eventually surrender their monetary goal of defeating this stubborn global inflation. Roubini would rather use “wimping out,” this central banks’ propensity to change their stance in midstream even before the mission is accomplished.

Very few would be prepared to argue against Roubini’s dark prognosis because it is a tale that seems to connect all the dots through all the global uncertainties and volatilities combined.

For instance, New Zealand’s Graeme Wheeler and Bryce Wilkinson in their July 2022 analysis put the blame for ultra-high inflation on ultra-easy monetary policy of central banks which were faced by the contractionary consequences of the pandemic lockdown. But Wheeler and Wilkinson also debunked the claim of many policymakers that inflation is of exclusively global origin given the disrupted global supply chain due to the virus and Russia’s invasion of Ukraine as it pushed key commodity prices to the sky. If it were true, the inflation rates in China, Japan, Switzerland, Saudi Arabia, and many Asian countries would be as high as the others. But they are not.

As they said, central banks committed errors of judgment and the Russian factor simply accentuated the build-up in price pressures. The US Fed, and for that matter, many central banks in the region including here, might feel alluded to because many of them thought, and they were proven incorrect, the inflationary pressures were simply transitory. Some monetary authorities even championed the cause of keeping low interest rates far longer than necessary until they saw clearer evidence of second-round effects, or inflation being more entrenched, as if leading indicators are not scientific enough.

What makes matters worse is that central banks violate their own rules of engagement. Some would always attest they are forward-looking in conducting monetary policy. Yet even as their own forecasts are showing higher-than-target outcomes, they would prolong their monetary accommodation. It looks like they have become oblivious of their primary mandate which is to promote and preserve price stability. Thus, the current BSP governor was right when he said that price stability, and not growth, is the mandate of the BSP. Economic growth could be a guidepost of monetary action because not all inflation undermines growth.

We sympathize with Dr. Raul Fabella who saw a policy dilemma in the choice of “whether to go for growth first and inflation taming later, or inflation taming first and growth later?” But for central banks with price stability objective, there is singularity of goal. Inflation busting is their mission order, their primary responsibility. In the Philippines, it is no less than the 1987 Philippine Constitution that mandates the BSP to maintain price stability conducive to a balanced and sustainable growth of the economy and employment. Keeping prices stable is expected to lead to good trajectory of growth and employment. Its own charter as amended by Congress even strengthened the BSP’s capability to do its job as an independent monetary authority. 

We don’t even see a policy dilemma here because the economy is far from recession, whether this year or the next, at least based on what the Government is projecting in terms of a 6.5%–8.5% growth range. The policy issue is no longer to tighten or loosen monetary policy, but to what extent and for how long do we tighten the screw.

A whole-of-government approach is therefore needed because of the multifaceted nature of this crisis. With the BSP manning the monetary levers, the rest of the Government ought to mind and do their own share of lifting all the boats whether small or big. We should cover all grounds instead of choosing one against the other, or doing one now and doing the other later.    

What complicated the job of central banks, including the BSP, is what the New Zealand public sector economists described as a case of overdoing interest rate cuts in 2020 and 2021, and their failure to promptly exit from ultra-easy monetary policy. Like in the US, many labor markets in both advanced and emerging markets succeeded in recovering from their double-digit unemployment during the peak of the pandemic. This, plus the creeping inflationary pressures from the global oil market, the disruption in the global value chains and the emerging second-round effects should have alerted the monetary authorities all over the world to initiate their exit strategy earlier. 

As a result, central banks are now playing catch up in a big way, and paying higher interest on the banks’ excess reserves due to previous ultra-easy monetary policy including, in the case of the Philippines, reduction in the required reserves and purchases of government securities from the secondary market. These alone infused more than a trillion pesos into the money stream.

How central banks blundered in their conduct of monetary actions is traced on one, their overconfidence in their monetary policy framework and models; two, their overconfidence in their ability to fine-tune economic activity; three, their distraction from their primary responsibility of keeping prices stable instead of branching out to other roles not too central to their mandate; four, their notion that they have dual roles. It was also suggested that perhaps, some central banks might have also pandered to political objectives of those in authority when science and independence should have prevailed in monetary policy decisions.

There has been no lack of voices in the wilderness. Former US Treasury Secretary Larry Summers in February 2021 also warned central banks and governments by questioning the US’ $1.9 trillion pandemic response. At the time, Summers predicted: “There is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation.” As we wrote in our column last April 21, 2022, US inflation then stood below 2.0%. In March 2022, inflation skyrocketed to 8.54%. Summers advocated quick, immediate and decisive monetary tightening. Unfortunately, many central banks balked at the idea. It was not good for growth, it was not good for politics. Today, with high inflation, consumption and investment expenditures have been both emasculated. This is far from solving a policy dilemma; central banks had made their choice and the world is poorer because of it. Central bank independence has been weakened.

That is precisely Roubini’s beef against many central banks. For him, given this situation, the optimal response is to avoid de-anchoring of inflation expectations. This is a mouthful of theory because this means, central banks should resolve the issue of the so-called time inconsistency of their policy, that when they are expected to do the right thing, they would do it with dispatch. This is the reason central bankers should always be discrete before they conduct open mouth operations. This is the reason why clear forward guidance is treated like another monetary instrument.  Otherwise, society will be suspicious of their competence and credibility. That is how to lose the fight against inflation.

Given the suggested optimal choice, Roubini sees two problems. One, because monetary policy should sustain their tightening stance, recession becomes unavoidable. And two, because the Government needs to spend, and spend big, financial and debt crisis will not be far behind. With Roubini’s economic crash coupled with financial crash, central banks will need little convincing that the path of least resistance is to accommodate public debt. Summers’ vision of stagflation is therefore complete with central banks wimping out.

Let us all wish and pray that the Philippines is not among those of Roubini’s two-thirds of emerging markets which “have these types of economic and financial fragility” that could exacerbate his perfect storm. Wimping out for the central bank is not an option.

Diwa C. Guinigundo is the former deputy governor for the Monetary and Economics Sector, the Bangko Sentral ng Pilipinas (BSP). He served the BSP for 41 years. In 2001-2003, he was alternate executive director at the International Monetary Fund in Washington, DC. He is the senior pastor of the Fullness of Christ International Ministries in Mandaluyong.