Kenneth Rogoff: Globalization and Central Banks - The Chicken and the Egg
Harvard Professor Kenneth Rogoff has a very thoughtful comment in the Financial Times about how central bankers have been able to keep inflation down and growth high thus helping the global economy ride the wave of globalization to the benefit of us all. Or wait a moment; this is the standard narrative - Rogoff takes on a different point and his obervations are definitely worth a read.
Let us begin then with the succes story of central banks as they are perceived ..
'Central banks’ near universal success in bringing down inflation over the past two decades has led many policymakers to conclude that they have pretty much solved the problem of high inflation, once and for all. Market participants have bought into this story, as evinced by a host of quantitative and survey measures.'
This is really a question of the chicken and the egg and Rogoff turns the tables asking whether central banks in fact have been helped by globalization and not the other way around.
'The advent of modern independent and anti-inflation-oriented central banks is one of the great success stories of modern economic science. But this story has been exaggerated. We should consider the possibility that the unprecedented pace of modern globalisation, recently emphasised by Ben Bernanke, the Federal Reserve chairman, might also have played a role. If so, what will happen if the winds of globalisation ever reverse course?'
Rogoff also talks about China's export of deflation/inflation and here I believe he ventures too far away in theoretical considerations. He is undoubtedly right but is this what we are seing or have China in fact exported deflation for some time and more importantly - is this changing as the Chinese supply side is tightening in low value added activities and manufacturing prices are being pushed up? Ah well now I am venturing afar :).
Rogoff's main point is that globalization has made the job so much easier for central banks than people actually realize ...
'Instead, one should think of the modern era of rapidly expanding trade and technology progress as providing a spectacularly favourable milieu for monetary policy. With hugely positive underlying trends, central banks have been able to establish and maintain low inflation while delivering growth results that have often outperformed expectations.'
The illusion of central banks' success; can it go on?
'But precisely because globalisation has produced such a steady stream of upward surprises, there is an element of illusion to central banks’ success, as most people have only sluggishly adjusted their expectations to the faster growth trends.'
'But life cannot always be this good for a central bank. If big Fed interest rate surprises are always cuts, markets will eventually catch on, ratcheting up inflationary expectations.'
What if, what if, what if ...
'So the question is: what happens if the winds of globalisation turn? What if a combination of economic and political problems leads to a sharp slowdown in China? What if security checks in the wake of a terrorist attack lead to a sustained pause in the expansion of global trade? What if a slowdown in trend growth exacerbates the fiscal problems that most countries are already going to face as their populations age? Or, more immediately, what if there is a disorderly unwinding of the oversized US current account deficit? Having built up public expectations about their ability to deliver high growth and low inflation simultaneously, central bankers might have a hard time explaining what went wrong.'
Central bankers should not take all the credit ...
'Thus, there is some urgency in the need for central banks to take greater pains to avoid taking too much credit for upside performance.'
But the current conjuncture is just a small test compared with what might happen if globalisation hits a really large bump in the road. Then, at least in a few big countries, inflation will end up being far higher than policymakers or market participants now seem to think possible. Market convictions that inflation is forever dead will be shattered.'
So do I agree with Rogoff's analysis here? With some reservations, with some reservations ... I agree that conditions in the global economy might very well be changing and thus that the large central banks very well could be in for a turret time but I don't think Mr. Rogoff is right in arguing so ardently that the guidance of central banks has been an illusion driven by the exogenous factors of globalization; I mean has globalization really a force coming entirely from the outside? My own argument about China's export of deflation certainly denotes a 'help' to the central banks but the convergence of market expectations to the gradualist and 'adversity to reversal' attitude of modern central banking is something which has been built upon institutional changes in the economy or am I getting too idealistic here?
On a last note, I clearly think that central banks should be critisized and questioned by the market and commentators (I am certainly there :)) alike and to this end Rogoff's perspective and analysis is important and also because it proposes and alternative view of a very well known narrative and this is always good.