What US Fed Chief speech in Jackson Hole symposium signals for the world, and for RBI

Despite Powell not furnishing further details, these are significant observations. Almost immediately, bond yields of all tenures — 2-year, 10-year and 30 year — fell sharply, even as the US dollar weakened and stock market indices — S&P 500, Nasdaq 100, Russell 2000 — registered sharp gains.

The impacts of Powell’s observation will not be limited to the US alone, and it can be expected that stock markets around the world will jump when they open next.

What is the Jackson Hole symposium?

Every year since 1978, the Federal Reserve Bank of Kansas City has sponsored a symposium to discuss a particular issue faced by the US and world economies.

Central bankers, finance ministers, academics, and financial market participants from around the world participate in the symposium to discuss the economic issues, implications, and policy options pertaining to the theme of that year. Symposium proceedings include papers, commentary, and discussions.

Since 1982, the symposium has been hosted at the Jackson Lake Lodge at Grand Teton National Park in Wyoming.

Why does the symposium matter?

The symposium, and especially the comment by the head of the Federal Reserve, are watched by policymakers and market participants globally because they provide clues to what is happening in the world economy, and where things may go.

For instance, in 2007, just before the world plunged into the Global Financial Crisis after the US housing market unravelled, the theme at Jackson Hole was “Housing, Housing Finance, and Monetary Policy”. In 2021, as the world had started to make sense of the effects of the global pandemic that had literally shut down all economies, the theme was “Macroeconomic Policy in an Uneven Economy”.

This year’s theme is “Reassessing the Effectiveness and Transmission of Monetary Policy”. According to the official website: “This year’s theme will explore lessons learned from the response of monetary policy to both the pandemic and the subsequent surge in inflation.”

Data on US economy.

What does monetary policy refer to? Why is it important?

At the heart of the discussions in Jackson Hole is monetary policy, which is essentially about tweaking the availability of money for loans and the price at which these loans are given in any economy (the ‘interest rate’).

Typically, the main responsibility of all central banks is to maintain price stability in the economy. This means ensuring that money maintains its value over time — or the same quantity of money buys roughly the same amount of goods and services tomorrow as it does today.

Often, like in the US, there is a dual mandate — the central bank has to ensure price stability while maintaining low levels of unemployment. The key challenge before a central bank is inflation, or the rate at which prices rise from one year to another. When inflation rises, central banks raise interest rates so as to depress economic activity, and thus bring down prices of goods and services. But as soon as they succeed in this goal, they are faced with the problem of slower growth and rising unemployment as a result of economic activity faltering.

A central bank is judged for the timing of its policy actions — both in containing rising inflation as well as preventing a sharp rise in unemployment or a sharp fall in economic growth. Timing of monetary policy action is a tricky subject because it often takes time for the monetary policy decisions of the central bank to affect the economy. This is the “transmission” that this year’s theme refers to.

The theme also refers to “effectiveness” i.e., whether or how far monetary policy has been successful in containing inflation. If inflation has spiked purely because of sudden supply constraints — for instance, lower levels of food items being produced because of deficient rainfall — then higher interest rates may not be effective in bringing down prices.

Over the past five years, central banks have been buffeted by macroeconomic shocks that have pulled policy in different directions. The pandemic lockdowns destroyed economic activity and led to a sharp rise in unemployment. In response, all central banks resorted to easy monetary policy — even as the governments resorted to expansive fiscal policies (pumping money into the economy). The net result of these two factors as well as supply disruptions was a rise in inflation. This happened all over the world but more so in the US. The Russia-Ukraine war made matters worse, and sent inflation rates skyrocketing to historic highs.
As a result, central banks around the world had to sharply raise interest rates.

As things stand now, most developed economies have lost momentum as a result of the “tight” monetary policies of central banks. There are perpetual worries about recession.

Why is Powell’s statement significant?

For some time now, stock markets and global investors have been waiting for a clear signal about the Fed’s policy cycle. Powell saying that “the time has come for policy to adjust” essentially means that the Fed is now more bothered about containing the unemployment rate than the inflation rate. Put differently, it means there will be no more hikes of interest rates — in fact, signals are that a rate-cutting cycle is about to start.

Lower interest rates imply a boost to economic activity because it will become cheaper to borrow money, whether it is to buy a car or invest in building a new factory. That is why stock markets are rising — market participants see a period of economic activity sustained by progressively lower interest rates.

Does the statement find an echo in RBI?

There are several points of divergence between the US Fed and RBI. First, the target inflation rate is 2% for the US and 4% for India. Second, in the last few years, the quantum of increase in the policy interest rate in the US has been almost double that of India, partly because US interest rates were close to zero before the rate cycle. Third, in terms of percentage points, inflation has fallen more in the US than in India.

Powell’s signal towards the start of the interest rate-cutting cycle is something that finds resonance in many countries. The European Central Bank has already cut its deposit rate once (by 25 basis points) in June.

The RBI hasn’t cut rates yet but as the minutes of the latest Monetary Policy Committee show, there is a growing sense among members that interest rates may be too high. At least two out of the six members of the MPC voted for a cut. The dominant RBI view, however, is still to be watchful of inflation.

RBI’s reluctance to cut also has to do with the fact that, unlike the US (where recession fears abound), India is clocking world-beating GDP growth rates at the moment. As such, there is less pressure on RBI to cut rates and more pressure to ensure inflation doesn’t resurface again.