A void at the center
A lot of ink has already been spilled parsing Jerome Powell’s speech at last month’s conference of central bankers in Jackson Hole, Wyoming. The US Fed chair’s remarks at the annual event are always the subject of close attention from Fed-watchers. This year, with the course of monetary policy very much up for discussion, the FOMC felt the need to communicate its resolve to tighten monetary conditions, even if that tightening incurs a political cost (“some pain”). Markets’ reaction suggested that the message got through.
But Powell’s speech was not the only item on the Jackson Hole agenda. I found more interest in decoding some of the other speeches at the event, in particular the remarks of the IMF’s Deputy Managing Director Gita Gopinath and those of General Manager of the BIS Augustín Carstens.
Soon Parted is about the plumbing of the global payment system. It is not surprising that the technocratic managers of such an arcane set institutions would sustain an alliance with academic economics, as performed at Jackson Hole. That alliance, however, is not without tension and even irony. The very thing that makes central banks central is their position in the payment system—the plumbing is what central banks are at the center of. But academic study of central banks studiously avoids any mention of the payment system!
A macro framework without plumbing
Both Gopinath and Carstens made wide-ranging, big-picture interventions, suited to the forum. I found myself struggling to connect their arguments to the data I know how to observe. The origin of that disconnect is in the framework of aggregate supply and aggregate demand, which both speeches used.
This way of thinking, completely standard within academic macroeconomics, accounts for macro spending flows by organizing them into two broad aggregate sectors, a demand side and a supply side. The T accounts below describe such a world at its simplest, using flow accounting (sources and uses). Businesses, the supply side, use the proceeds of their sales to pay wages to their employees; households, the demand side, use these wages to buy the output of businesses. Households accumulate savings, which becomes the source of funds for business investment.
Within the conversation of academic macroeconomics, this is a good thing to do, because it makes aggregate price determination into a textbook microeconomics problem. Aggregate supply and aggregate demand, that is, is just supply and demand. If prices are high, it is because demand is high, or supply is low, or both. This is more or less the approach of most undergraduate macroeconomics. Certainly, the models used by central bankers have more moving parts than does my schematic version. But in the end, both in their models and in the way they talk about what is going on, central bankers think using supply and demand when they speak to academics.
Dr. Gopinath’s remarks, for example, argue that it has become difficult to get a sense of supply-side “slack.” If there is slack, then supply can expand to meet rising demand without causing inflation. On the other hand, if slack was thought to be high but turns out actually to be low, then rising demand does lead to inflation. Gopinath places a fair bit of weight on this kind of error, and it enters her reasoning as a supply-side factor.
For Carstens, the issue is not so much mismeasurement, but rather complacent policy-making that allowed fault lines to accumulate. Politics, technology, globalization and demographics lowered price pressures, allowing central banks to keep monetary conditions loose. But then cheap money meant that debt substituted for productivity improvement on the supply side, setting the stage for a “rude awakening” to pandemic and war.
An everyday political irony
The keepers of the monetary plumbing align with academic economists. One could be forgiven for having assumed that the reason for this alliance is that economists have carefully thought-out ideas about the best way for central bankers to do their jobs. But this is not at all the case: economists’ theories, for the most part, have a void where the plumbing is supposed to go. Academic conversations about what central banks should do make startlingly little mention of what central banks actually do.
But then why go spend so much time pretending that they are talking about the same thing? Is Jackson Hole mostly a public exchange of legitimacy for relevance? And who is minding the plumbing in the meantime?