The Real Stakes at Jackson Hole this Year

Originally published at Project-Syndicate | August 25th, 2022

With inflation at a 40-year high in many countries, central bankers and businesses are understandably focused on the question of what monetary policy should look like in the near term. But they must not let that distract them from bigger issues stemming from the balkanization of the global economy.

JACKSON HOLE, WYOMING – This week, I am attending the US Federal Reserve Bank of Kansas City’s annual meeting alongside US Federal Reserve Chair Jerome Powell and other central bankers, policymakers, and economists. This year’s gathering – the first to take place in-person since the pandemic – is unfolding against a backdrop of weak global prospects, widespread recession fears, and threats of ever-higher inflation. The Fed will doubtless seek to reassert its credibility as a serious inflation fighter. But because the surge in prices is being driven by such a wide variety of factors, the effectiveness of monetary policy may be limited.

For example, massive levels of quantitative easing (central-bank asset purchases), multiple rounds of stimulus checks from the government to households, and an environment of persistently low interest rates (dating back to the 2008 financial crisis) have intensified the post-COVID bump in aggregate demand for tradeable goods and services. And asset appreciation – especially in real estate and stock portfolios – has spawned additional wealth effects, stimulating consumption by people who have come to feel richer.

Conventional monetary-policy tightening is largely about demand destruction. When a central bank raises interest rates and reduces the money supply by curtailing its monthly asset purchases, these measures should quash – or at least curb the growth of – aggregate demand.

But there is far less that monetary policymakers can do about the supply-side factors that are also fueling inflation. We therefore should not be too sanguine about the Fed’s ability to bring inflation back down to its target range of 2% per year.

Many of the supply-side factors are external to the United States. In China, the world’s largest supplier of goods and services, the government’s “zero-COVID” policy has severely restricted everyday life and curtailed production. And, globally, unprecedented heatwaves, labor shortages, and travel and logistics complications have further disrupted supply chains. With labor-force participation rates not recovering to their pre-pandemic levels, hiring difficulties have hindered companies’ ability to meet the demand for their goods and services. Early retirements, employee burnout and turnover (implying higher retraining costs), and productivity losses from remote work have all fed concerns about a reduced potential labor supply and higher wages.  

And, of course, Russia’s war in Ukraine has fueled severe energy and food shortages and price spikes, compounding problems caused by years of underinvestment in hydrocarbon production and refining capacity. Owing to the rapid rise of ESG (environment, social, and governance) investing, trillions of dollars of capital investment have been diverted from the traditional energy sector, creating the conditions for today’s heightened energy-security concerns and price volatility, especially in oil and gas.

To be sure, interest-rate hikes can have some indirect effects on these supply-related price increases. For example, a Fed-induced slowdown or recession could change workers’ attitudes toward available work opportunities, thereby easing the labor-supply issues. But for the most part, these supply-driven factors are beyond the Fed’s direct reach.

As such, government, corporate, and financial decision-makers should start preparing for a world of stubborn inflation in the mid-single digits. After years of inflation falling below central banks’ target rate, this change will have big implications for how capital owners model risk and allocate investment. The increase in capital costs (from higher interest rates) not only might translate into higher cash outflows for companies (to pay for rising debt commitments and liabilities, for example); they also will constrain firms’ risk appetite, reducing investment.

After all, the broader global trends toward deglobalization and Sino-American decoupling mean that the win-win outcomes offered by globalization may no longer be available. It may now be more prudent to adopt a zero-sum or win-lose perspective. All the old models’ core assumptions – from the reliability of cheap capital and a global carry trade to a free flow of goods and workers and multilateralism in international affairs – have been called into question.

As the world economy becomes more balkanized, companies and investors will be less able to diversify across global markets. Portfolio positions therefore will become more concentrated, increasing the need for higher rates of return. In practice, this means that investment flows will likely shift from emerging economies and struggling Europe as investors choose between the US and China.

On balance, the debates about current inflation and the next few months of monetary-policy changes threaten to distract from these larger trends. Major economic fissures are emerging, and they will force business and government leaders to place greater bets on specific regions as the overall appetite for risk declines.

Inflation matters, of course. But the world’s people will be best served if decision-makers focus more on how the investment landscape and allocations of capital will look in a deglobalizing, de-financializing economy.

Dambisa Moyo: an international economist, is the author of four New York Times bestselling books, including Edge of Chaos: Why Democracy Is Failing to Deliver Economic Growth – and How to Fix It (Basic Books, 2018).

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