The recent Kansas City’s Federal Reserve Bank’s annual conclave in Jackson Hole, WY, (https://www.kansascityfed.org/research/jackson-hole-economic-symposium/jackson-hole-economic-policy-symposium-reassessing-the-effectiveness-and-transmission-of-monetary-policy/) was an opportunity for leading central bankers and academics to discuss monetary policy issues. Andrew Bailey, the Governor of the Bank of England, presented a paper titled “Reflecting on Recent Times “ (https://www.bankofengland.co.uk/speech/2024/august/andrew-bailey-speech-federal-reserve-bank-of-kansas-annual-jackson-hole-economic-policy-symposium) to discuss the monetary policy responses to the twin shocks of COVID and the war in Ukraine.
Bailey distinguished between financial stability and monetary policy objectives.
The COVID shock led to concerns about financial stability, which required an immediate and massive monetary policy response (zero interest rates and massive increase in CBs balance sheets). However, it was followed by a global bout in inflation that required a measured and gradual monetary policy response.
The initial discussion was about the nature of the inflation shock: transitory or structural. By 2021, there was a recognition that inflation was endemic and beginning of the tightening cycle. However, in contrast to the response to financial stability concerns, dealing with inflation is a gradual process (i.e. a series of measured benchmark rate increases). The central bankers have to take into account changes in the nature of monetary policy transmission, non-linearities and concerns about second and third round effects—in particular the impact on economic activity and labor markets. In Bailey’s view, the key element in determining the monetary response, given the lags, is to look at the wage/price behavior.
In looking at the future path of monetary policy, we have to decide whether we feel that disinflation is taking hold (self-correcting) , or whether we need to squeeze the economy further. In this regard, Bailey believes that we are in a more benign phase, with well-anchored inflationary expectations. In a way, he is declaring victory, at least cautiously.
Looking at the post-COVID experience, Bailey states we have to look at trade-offs between financial stability and monetary policy. How do we react to shocks?
Bailey says: “This is what we call the trade-off language. We are not alone in having this type of language in our remit. The language applies when the economy is hit by temporary cost or supply shocks. In these circumstances we have to judge the appropriate balance of inflation and output volatility, when judging how quickly to bring inflation back to target”
Bailey also looked at changes in the monetary policy paradigm. Monetary orthodoxy requires that central banks focus on inflation targeting. However, there are other aspects we have to take into account. First, how to operate monetary policy near to the lower bound of interest rates. Second, in a more uncertain and volatile world, how to set policy in an environment where shocks may or may not be short-lived. And, third, how to ensure that we can at all times meet both our monetary policy and financial stability objectives, including when they may be pointing in opposite directions.