The global inflation crisis put the world’s central banks in lockstep for the past year, raising rates nearly in unison. But the economic landscape has changed, and diverging policies could spell trouble down the road.
So how should central banks coordinate when their economies are headed in opposite directions?
It’s a topic that is on the table this week as central bankers from around the globe descend on Jackson Hole, Wyoming, to discuss “Structural Shifts in the Global Economy” at the annual economic policy symposium hosted by the Kansas City Federal Reserve.
In her speech at the symposium Friday, European Central Bank President Christine Lagarde warned that we “may be entering an age of shifts in economic relationships and breaks in established regularities.”
“For policymakers with a stability mandate, this poses a significant challenge,” she added.
Working through post-pandemic shocks
Communication and coordination between central banks have been vital for the past three years. And since the start of the pandemic, international monetary policy has looked striking similar. From the United States to Saudi Arabia to Malaysia, many major world economies slashed interest rates to historically low levels in March 2020 to stimulate their economies amid Covid lockdowns. Many have since begun to hike interest rates aggressively in the last two years.
But while the early years of the pandemic affected much of the world’s economy in similar ways, the rebound has not been identical, and some countries, including the United States, are recovering faster than others.
International monetary policy — once in lockstep — is beginning to diverge.
Stalled rebound in China
The Chinese government surprised investors earlier this week by deciding not to cut a key interest rate that influences mortgages. And it cut its one-year rate, which affects personal loans and business loans, for the second time in three months.
The move comes as Chinese consumer spending, factory production and investments in long-term assets like property or machinery all slumped last month. Youth unemployment has hit record highs, while an ongoing real estate and debt crisis has investors fearing the worst.
That shift in monetary policy is significant because of the country’s importance to overall global economic health. China represents around one-fifth of global gross domestic product, the broadest measure of economic activity.
And China’s increasing isolation from the rest of the world — which was exacerbated by its “Zero-Covid” policy — has amplified the differences in its post-Covid recovery, compared to other major economies, according to Wells Fargo international economist Nick Bennenbroek.
“We are facing a deepening geopolitical divide and a global economy that is fragmenting into competing blocs,” Largarde said Friday.
She added that central bankers would need to provide “clarity, flexibility and humility” as the global economy enters a new age of “shifts and breaks.”
Is communication always the answer?
Central bankers do “talk a lot, and we see each other quite a bit,” said Andrew Bailey, Bank of England’s president, at a June event hosted by the European Central Bank. “It’s important that we do that, and we share wisdom on how we’re interpreting the things going on around us.”
But not everyone agrees that central bank alignment is the best policy.
“Adopting formal global monetary policy cooperation could plausibly erode central bank credibility and public support for central bank independence,” former Federal Reserve Vice Chair Richard Clarida said at a 2021 Asia Economic Policy Conference.
Close coordination could also have unintended consequences on the global economy, said Bennenbroek.
“There’s always a risk that if everybody’s doing everything all at once and doing it very, very quickly, there’s the chance that we raised interest rates too far because we don’t really have time to fully assess the impact,” Bennenbroek said.
We may learn more about the Fed’s stance on the rearranging global economic picture when Chair Jerome Powell delivers his keynote address at Jackson Hole on Friday morning.