FRANKFURT- Having struggled to lift anaemic inflation for years, officials including the heads of the ECB, the US Federal Reserve and the Bank of England will attempt to figure out why monetary policy is not working as it used to and what new role they must play in a changed world – be it fighting inequality or climate change.
For now, the only consensus is that the economic order is shifting.
Globalization, climate change, digitalization, ageing populations, rising inequality and the coronavirus pandemic are changing consumer habits, keeping a lid on prices and pushing down, sometimes below zero, the interest rate needed to keep inflation stable.
“Whatever are the structural factors hiding behind the observed decline in natural interest rates, the downward trend poses important challenges to the existing monetary policy frameworks,” Klaus Adam, a professor at the University of Mannheim, wrote in a paper that will be presented at the symposium.
Central banks’ failure to achieve their targets is beginning to challenge a key tenet of monetary theory: that inflation is always a factor of their policy and that prices rise as unemployment falls.
Indeed, the ECB and the Bank of Japan have both kept rates in negative territory for years, turning standard practice on its head by effectively rewarding banks for borrowing from them.
More worryingly for some, the two have more than doubled their balance sheet since 2015 to almost $15 trillion, inching closer and closer to directly financing governments a traditional red line.
Yet inflation barely nudged up even before the pandemic and is now negative in the euro zone.
While the Fed hit its own target, it never managed to normalize policy and with the pandemic plunging the world into a new recession, it too is testing the limits of policy as it hoovers up government debt.
Having pushed policy into unchartered territory, even at the cost of some legal challenges, with oversized bond purchases and negative rates, central bankers are now discussing doing even more.
The Fed is now openly talking about wanting to help lower income families, while the ECB is calling for a greater role in the fight against climate change.