Central bankers must move beyond 'we don't know' on rates

Higher mortgages, more stress.Photographer: Brent Lewin/Bloomberg

Three years into Covid and the upheaval it unleashed, the supreme beings of the economy are still in IDK mode. They need to regain some of their omnipotence. Not hubris, but that former sureness of touch is needed now more than ever. Unfortunately, it's proving elusive.

It was fine in 2020 to profess uncertainty about the path of the virus and the financial tumult it would produce. Central banks were supposed to have found their bearings by now. But instead of moving confidently toward a pause in interest-rate hikes they often sound and act like they are captive to events. Being responsive to dramatic developments is fine, but you also need to identify a strategy and stick to it. Too much thinking out loud can be unsettling and, at times, counter productive.  

It's one thing to profess dependence on data. It's quite another to be led around by numbers on a monthly basis. Federal Reserve Chair Jerome Powell sailed perilously close to that mark Tuesday when he opened the door to returning to increases of 50-basis points in the Fed's main rate. Was he acknowledging that scaling down in January from last year's jumbo hikes was a mistake? Over the years, the world economy and financial markets had grown accustomed to the idea that central bankers were all-seeing and all-knowing. 

After rattling markets, Powell softened his tone a day later. No decision has been made, he stressed. His recalibration made it look like sticking with quarter-point nudges is the base case, even if it isn't a lock. Depends on the data, of course.

The Fed isn't the only one making data dependency look torturous. Hours after Powell flagged the prospect of a half-point move, Philip Lowe, governor of the Reserve Bank of Australia, was emphasizing his "completely open mind." Lowe had just finished saying that a rate pause is on the bank's agenda. A breather after a year of relentless hiking would be a good thing. But the RBA has been wrestling with communications. After first raising the prospect of a pause late last year, the bank released a surprisingly hawkish statement in February only to raise eyebrows this week with a more dovish construction. Which is it, or could it be neither?

Challenged on this point, Lowe said the overall message doesn't change much. The idea is that inflation is too high, it has to return to target and rates are the tool the bank possesses. The current policy-setting environment is fraught, "with many of the variables we monitor at near record highs or lows," he told a conference organized by the Australian Financial Review. 

Underneath this lack of conviction is a the global debate about how restrictive policy needs to be. Core to this discussion is flux about what level of borrowing costs — adjusted for inflation — can be characterized as neutral, something that neither juices nor constrains the economy. This point, known as `R*,' moves around and isn't definitive. What many agree on is that after decades of being low and declining, the level has moved higher. But how much and for how long? 

Former US Treasury Secretary Lawrence Summers and Olivier Blanchard, one-time chief economist at the International Monetary Fund, took opposing sides on this question at the Peterson Institute for International Economics on Tuesday. Summers, who has chided the Fed for timidity, sees significantly higher rates into the distant future. Blanchard isn't entirely sold. Asked at the Senate panel Tuesday of his own perspective on neutral, Powell responded that it was tough to pin down. "We have this shock — series of shocks — associated with the pandemic," he said. "It does raise the question of, 'where's the neutral rate?' — Honestly, we don't know."

The issue isn't esoteric. Lowe gets lots of mail from people under strain. Unlike in the US, most Australian mortgages fluctuate with the central bank's main rate. The most aggressive tightening cycle in a generation has spawned real anxiety. Lowe says he tries to respond to most of them. He also says that, for the first time, he has begun getting correspondence thanking him for preserving the value of money. The governor has become a target across the spectrum from right-wing talk radio to the Greens party, in part because of guidance in 2021 that rates might not need to be lifted until 2024.

Lowe says that if inflation isn't brought to heel, the results will be still higher rates and a deep downturn. Underscoring the stakes, Lowe added that he'll be engaging with crisis-support services about the anguish in the community:

If inflation stays high, we know that will lead to higher interest rates, people losing jobs and more pain. That's the reality we face. It's an uncomfortable reality, but that's the reality, and it's a very difficult message for people to hear. People write to me how it's affecting their families and their mental health and … we're very alert to that and it weighs heavily on my heart.

Getting this right is more than just a question of basis points. It's about having faith in strategy. Empathy is fine, but monetary authorities weren't built for a popularity contest.

Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Previously, he was executive editor of Bloomberg News for economics. @Moss_Eco

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.