Economy

This week, Jay Powell, Federal Reserve chair, is in the spotlight — and pulpit. A year ago, he delivered a speech at that gigantic economic tribal gathering known as the US Federal Reserve’s Jackson Hole conference, pledging that inflation pressures would only be “transitory.”On Friday morning he speaks again — and it is now clear that this “transitory” message was totally wrong. It remains uncertain if he will apologise, or admit the mistake. But what is clear is that any numbers Powell cites will prompt investors to reappraise their macroeconomic models and forecasts. Fair enough. However amid this frenzy of number-crunching, investors should also take note of some intriguing research floating around the edge of the Jackson Hole meeting about the importance of storytelling in monetary policy.A couple of decades ago, this was a topic that garnered little attention at the Fed. For while anthropologists such as Douglas Holmes have long studied how central bank language and rituals influence the economy, economists used to assume this was less important than mechanistic models.However, after the 2008 financial crisis, Robert Shiller, the Nobel Prize-winning economist, urged his colleagues to study how “narratives” shape sentiment and thus economic trends. And one encouraging post-crisis development in economics is that a swelling number of young behavioural finance economists have heeded Shiller’s call. Last year a team spearheaded by Peter Andre surveyed 10,000 households and 100 economists and concluded that whereas economic “experts” attribute price jumps to cyclical demand swings, consumers blame supply issues such as government mismanagement. That perception, which is heavily influenced by media, causes consumers to project higher inflation for longer.This year another group led by Yongmiao Hong used machine learning tools to analyse inflation narratives in 880,000 Wall Street Journal articles. They concluded that “narrative-based forecasts perform better in the long-run forecasting” than numerical models, seemingly because the latter miss subtle economic signals and shifts. And this month Chad Kendall and Constantin Charles released research about extensive psychological experiments into how humans create explanatory frameworks to frame economic data. This shows that people almost always seek to fit new information into pre-existing narratives.But what is most interesting is that the shape of our storytelling matters, since “narratives with a particular structure may affect people’s actions by influencing the subjective beliefs they form from the data they observe”. More specifically, the experiments suggest that “lever” narratives, which present linear causality frames (A leads to B leads to C, and so on) have the strongest grip on people’s minds. So-called threat narratives, which describe how offsetting forces both avoid and cause particular outcomes, are less potent. The research also notes that people love “to share their homegrown narratives with other subjects, who are then persuaded by them”. All of this has practical implications for Powell, given that the Fed faces an increasingly bitter fight over inflation. Some Fed critics, such as former US Treasury secretary Lawrence Summers, are currently promoting one causality narrative — that this year’s spiralling inflation arose because of lax monetary policy. This implies that interest rates must rise to stop inflation.Fed officials, however, prefer another causal story according to which prices have jumped because of high energy prices and supply side shocks. This suggests that prices will fall if (or when) the initial shock of the war in Ukraine subsides, and/or economic activity slows down.There is a political tussle too: Republicans blame the Biden administration for inflation; Democrats blame it on external events. One consequence is that Pew research suggests that 84 per cent of Republicans think inflation is “a big problem”, but only 57 per cent of Democrats agree. This is a striking demonstration of why narrative causality matters.Of course, an intellectually honest economist might note that all these simplistic causal stories are essentially fictions, given that economic phenomena arise from complex interactions in the economy. The causality narrative being presented by the White House around its Inflation Reduction Act is also somewhat fictitious. While some measures in the legislation are sensible, they are unlikely in themselves to influence short-term price trends much, if at all. But Powell’s problem is that if he does not present a convincing causality narrative at Jackson Hole, others will offer one in its place. Simply describing what has happened in the past year, or proffering complex and competing explanations, is unlikely to pack much of a punch — or shape sentiment in the way that the Fed needs. So if I were his speechwriter, I would take a leaf from Paul Volcker’s book and argue that inflation will fall when rates go up, and promise to keep raising those rates until price growth is at a sensible level. That will not be politically popular ahead of a crucial midterm election. But it is at least a crystal clear message — or it would be if the Fed actually does it. [email protected] More

Industrial firms were originally ordered to restrict output from Aug. 17 until Aug. 24, but formal curbs were extended through Thursday and will be gradually relaxed “in an orderly manner” once weather conditions have improved, according to a notice issued by Chongqing authorities on Wednesday. Drought has devastated power generation in the Yangtze river basin, with hydropower accounting for around 80% of the electricity in neighbouring Sichuan province. Dwindling water levels have left generators operating well below their normal capacity. Pangang Group Vanadium & Titanium Resources Co Ltd told the stock exchange in a filing on Wednesday its Chongqing subsidiary had received the notice and would continue to suspend production. “The specific recovery time will be subject to the notification of relevant departments in Chongqing,” it said.Honda Motor Corp also said on Thursday its power product factory in Chongqing will remain closed this week. “We don’t know what to do until we see what the government tells us for next week,” a spokesperson said. The plant makes small-engine products like lawnmowers and tillers and doesn’t manufacture automobiles. Honda made 23% of all of its power equipment in Chongqing last financial year.The factory was on summer vacation until this past Sunday and suspended operations from Monday. Chongqing and other parts of the Yangtze basin have been broiling under weeks of temperatures in excess of 40 Celsius (104 Fahrenheit), causing crop damage and forest fires. Power rationing has impacted firms in sectors like battery making and solar manufacturing. Toyota Motor (NYSE:TM) said it had used an in-house generator at its Sichuan plant to resume operations. Although national forecasters reduced their heat alert level from “red” to “orange” from Tuesday, temperatures are still expected to exceed 40C until the weekend in some parts of the Yangtze delta. Sichuan province normally delivers large amounts of its surplus hydropower to other provinces, and coal-fired power plants in Anhui province and elsewhere have been under pressure to pick up the slack, according to state media. “It’s unclear how long this power will continue to be exported ex-province, considering the severity of the local power shortage, but cross-province transmission is usually given highest priority in China’s power dispatch planning,” said David Fishman, a power expert with the Lantau Group consultancy. “If these exports are suspended, already-tight power supply in eastern China, which is enduring its own heat wave, will be further affected,” he said in a research note. China’s State Grid Corporation is now delivering 130 million kilowatt-hours of power per day to Sichuan, state broadcaster CCTV said on Wednesday. Economists at ANZ said in a note on Tuesday it was unlikely China would see a repeat of last year’s nationwide energy shortages, which were caused by tight coal supplies, adding that the impact of the current power crunch on gross domestic product was “negligible” so far. More

Investing.com — The European Central Bank’s decision to raise its key interest rates by half a percent in July was opposed by some members of its governing council, according to the accounts of the meeting published on Thursday. The ECB said “a very large majority” of members on the council had supported the move, but noted that some were concerned enough by “looming recession risks” to advocate for a smaller step. By contrast, the decision to create a new tool to contain unwarranted volatility in sovereign debt markets was supported unanimously. The two decisions had been seen by analysts at the time as a ‘quid pro quo’, which would satisfy inflation hawks by raising rates faster than the bank had suggested at its June meeting, while also putting a safety net under the bond markets of Italy and other, financially weaker members of the Eurozone.In addition to the actual rate hike, which ended the ECB’s experiment with negative interest rates, the bank had also flagged that it intended to raise rates again in September. However, it had said its action in September would depend on the economic data, abandoning a policy of ‘forward guidance’ in a desire to maintain maximum flexibility in its decision-making. The accounts show a continued reluctance at the bank to accept the need for an overall higher trajectory of interest rates to deal with this year’s surge in inflation.”It was seen as important to stress that the 50 basis point hike did not constitute an upward shift in the interest rate path but rather a frontloading of the policy normalization,” the accounts said. One likely opponent of the move is board member Fabio Panetta, who told a conference on Wednesday that the ECB shouldn’t need to raise rates much more. “We may have to adjust our monetary stance further, but …. we have to be fully aware that the probability of a recession is increasing,” Panetta said. His comments contrast sharply with those of German ECB board member Isabel Schnabel, who said recently that rates are still well away from a level that could be construed as ‘neutral’ for the economy. The ECB’s accounts side with Schnabel, saying that its policy stance remains “accommodative”.In part, that is because the ECB has repeatedly underestimated inflationary pressure this year – something that was acknowledged in the meeting.”Once more, June had seen an inflation surprise, confirming the underestimation bias observed in the recent past when outturns were compared with earlier projections,” the ECB said.That trend has continued since the meeting, with Eurozone inflation hitting a new high of 8.9% in July. That means that real interest rates – adjusted for inflation – are still deeply negative.The euro, which has fallen to a 20-year low against the dollar amid the ECB’s reluctance to raise rates more aggressively, drifted marginally lower after the accounts’ publication but was still up a touch on the day at $0.9977. In the past, a cheaper euro has served the Eurozone well, ensuring robust demand from export markets such as the U.S. and China that has offset chronically weak domestic demand. However, the ECB’s accounts suggested a dawning realization that it can’t rely on such factors any more, due to the “deteriorating outlook” in the U.S., U.K. and China. “The point was made that the improvements in competitiveness and support for growth that would normally be associated with a depreciation were being impeded by the prevailing global supply constraints and logistics restrictions,” the ECB said. More

“I think it’s too soon to say …because we have some important data that’s coming up,” George said in an interview on CNBC from Jackson Hole, Wyoming, where her bank is hosting an annual economic symposium that will feature a keynote address on Friday from Fed Chair Jerome Powell.Asked if she would like to disclose her preference for whether the Fed lifted rates by 75 basis points for a third straight meeting next month or dialed that pace back to 50 basis points, George said: “No.” More

The ECB raised interest rates by 50 basis points to zero last month as inflation fears mounted, surprising investors with an unexpectedly large hike after the central bank had guided for a smaller, 25 basis point move. “Inflationary pressures were judged to have intensified,” the accounts, released on Thursday, showed. “Continued anchoring of inflation expectations was dependent on the Governing Council acting decisively on the worsening inflation outlook.”The ECB is expected to lift rates by another 50 basis points next month, even as the risk of a recession is rising, as inflation is now nearing double digit territory and looming gas shortages could push prices even higher. More

This is part of a series, ‘Economists Exchange’, featuring conversations between top FT commentators and leading economistsThe Bank for International Settlements is known as the central bankers’ bank. It does provide banking services for the world’s central banks, but more importantly uses its convening powers to provide a forum for discussing monetary and financial stability.With inflation hitting multi-decade highs across both advanced and emerging economies, the BIS’s view that nations are taking a big risk with inflation staying high for much longer than hoped, hit the headlines earlier in the summer.General manager Agustín Carstens said that instead of thinking that inflation could smoothly rise and fall, it was more likely to stick either in a favourable world of low-inflation around central bank targets of 2 per cent or in a dangerously high zone.In this discussion he explains his thinking that inflation could get stuck too high for a long time and what is needed to avoid it. Part of the medicine is for the public to experience rapidly rising prices, realising that they are something to be avoided almost at all costs.Chris Giles: Tell us about your idea that countries can live either in low-inflation or high-inflation worlds.Agustín Carstens: I think it’s very important [to note] that the function of inflation is not necessarily that obvious. At the end of the day, the definition of inflation is an overall increase in the price level. That gives the impression that all prices are moving at the same time, at the same pace, and the reality is that that never happens.Usually, when you have a low-inflation regime, what you see mostly is relative price changes [some prices going up and others coming down], and these shape production and consumption decisions. These do not give you particular information about the overall pressures of inflation.

But if, at some point, you start seeing that more prices are rising and that those rises tend to be more persistent, that means individual price changes carry more information. That starts a process where firms start revising their prices more often, and feeds back into different loops. Cost gets affected, labour markets start responding. And instead of stabilising, high inflation becomes self-reinforcing.CG: If we could just stay with the low-inflation regime for now, what does this regime allow central banks, companies and households to do? Why is this such a nice world to live in?AC: First of all, you can disregard inflation. You can be inattentive of inflation. You have one less thing to worry about.CG: Presumably, companies can make longer-term decisions or lock in longer-term contracts as well.Agustín Carstens says the slowdown has started from a point of strength in the financial markets, quite an active economy and very high employment which will give resilience to the process © Mikael Sjoberg/BloombergAC: Absolutely. The issues that affect the outcome of your decisions, in a way, are more in your control, are more in your own environment. They have more to do with your own sector, more to do with what your market is. Of course, there are general market conditions to worry about, but if you really don’t have to worry about the value of money in the future, that’s huge.That translates into a relatively flat Phillips curve, which gives [central banks] a little bit more leeway to implement active monetary policy to respond to the business cycle without fearing that the consequence will be immediate or very quick inflation. Therefore, that enhances the stabilisation role of monetary policy, as we saw during the last 10 to 15 years.CG: So, if you’re in a stable low-inflation world, the central bank can, for example, look through oil price changes if they’re of a reasonable size and relatively shortlived.AC: Absolutely, and that happens even in emerging markets. I have a lot of experience in Mexico, and of course there it was very difficult to deal with double digit inflation. But if the people understand that this is a transitory change, that allows you not to force an adjustment in other prices that have not been affected.CG: Now tell us about the high-inflation world. How is that different, and how do then people behave in a world of persistently high inflation? And how high does inflation have to get to be in this world?AC: I guess for advanced economies, something higher than 5 per cent is already high, and in emerging markets, probably 7 per cent is the floor.I think the main issue is that it forces you as a firm and also as a labourer to be far more aware about your pricing decisions. And you have to really think about whether and when you are going to adjust prices, and by what amount?

If, for example, you’re in a low-inflation environment, you take those decisions based on a relatively long horizon because they’re conditions that you can anticipate, and you can optimise. Whereas when you have high inflation, you are observing multiple shifts and therefore you have to start deciding how are you going to adjust your price. Certainly, it means that you will adjust prices with more frequency and, or by higher amounts.CG: And presumably, in the high-inflation world, ultimately wages need to follow prices higher as well, so there’s a wage price spiral.AC: Yes. A key aspect here is that indexation and wage agreements are not revised so often, but at some point, the future arrives and then they start kicking in, and that can give a new boost into inflation. And I believe, in some economies, we are starting to see that.If there are more co-ordinated negotiations, if there is an indexation process, as the labour settlements respond more to the overall conditions of inflation rather than to focus really on the sector, then it’s when you start getting a more entrenched, I would say, inflationary dynamic.CG: What is the evidence that we are seeing this inflationary dynamic?AC: I think that financial conditions are that impulse why everyday demand has been sustained. So, that gives an additional impetus to the individual price changes. And that has come with a combination of very salient prices increasing. It is this combination that is giving you the increasing price as well.CG: Yes, why did we get here?AC: More than anything, the business cycle changed in a very dramatic way, in a very short period of time.In 2020, we were fearing deflation and a major depression. And governments said let’s use all the instruments we have to mitigate the impact, let’s flatten the curve of mortality of firms, let’s get the economy going. Now, we were surprised in the first instance by a very quick recovery, and that had to do with the vaccination.And that brought us into a dynamic that started to feel like inflation was getting traction, but then this process was supported, again, by the commodity shock that resulted from the Russian invasion.Monetary policy doesn’t have the nimbleness to adjust itself quickly with the business cycles, and that’s also something we need to take into account into the future.CG: How sure are you that we are now in this high-inflation world? Would you diagnose that to have happened in many countries, or is it a risk that it will happen?AC: I think that the warning lights have been blinking, and what I feel relatively comfortable [with] is that the policy response has been swift. I think once there was a conviction that we were not dealing with a few relative price changes, the response has been strong.

And therefore, I think this provides the opportunity for these very high inflation levels not to be entrenched. Some inflation expectations are being revised downwards, and also expectations in some markets which have a lot of inflation, that the policy tightening that we need in the future will not be so tight. So, I think the response has been opportune, and it’s still early, but so far, I think, so good.CG: If we’re talking about a transition back to a low-inflation world, how difficult is that? When we’ve got strong demand in many parts of the world, at least in excess to supply capacity, does this mean that you need to create more than a downturn?AC: We will necessarily see a slowdown. As a matter of fact, it’s a desired slowdown in the short term, because that will establish the conditions for much better growth in the medium term. And I think the key aspect that will really determine how deep the economy could go down, is the nexus between the real sector and the financial sector.So far, markets have adjusted relatively well. Yes, there have been some important valuation corrections, but markets are behaving well, and their mediation process is going fine. So, I’m not anticipating a major collapse in the financial markets. If this were to happen, then the impact on aggregate demand would be stronger, and that would probably bring inflation down faster, but from an output point of view.A positive thing is that we have started this from a point of strength in the financial markets. I think that will give resilience to the process. We also have, as you said, a quite active economy, very high employment, so that should keep resilience.But yes, needless to say that some slowdown will happen, will need to happen. I still think that we can pull this off without a major slowdown in the real sector.CG: And what are you looking for? What will be a sign of success in terms of re-embedding a low-inflation environment?AC: I think a very important sign would be, for example, if the percentage of different goods and services that are producing positive changes suddenly starts decreasing. Because then, you start seeing that the overall component of inflation is coming down, and relative price changes are starting to kick in back again.So, to have that metric I think is very important. In your CPI, you can have the analysis to sectors. If you see that 90 per cent of the sectors have positive increase in prices, and now it’s 85 per cent and then it’s 70 per cent, and then you get back to normal, I think that starts giving you signals.

And it’s also important for the central banks to enhance the information there. I think it’s very important to let people know what is happening with those prices, and show them that the adjustment process, the way you anticipate it, is taking place.At the end of the day, with the tightening of monetary policy, you want firms and price centres to say, if I increase prices today and the monetary policy is tightening, I might have a real increase in my price. That might affect my demand, and therefore I better fix down my price adjustments.CG: Is it therefore useful occasionally, every few decades or so, to have an inflationary period, so that people understand actually what inflation is and realise that it’s a bad thing?AC: I understand your point, not that I like it. But at the end of the day, central banks have to show their contribution to society, not only by providing money, but by providing money that preserves its value.And to have an institution in the state, with the unique or the primary objective to keep price stability, people need to appreciate the consequences of not having price stability.If you have never experienced inflation, then the central bank has a mandate that it might be very good in writing, but we haven’t seen it in action. So, the public interest of the central bank is huge, and therefore to test the ability of the central bank is important, so that the central bank can show what it delivers for society. I think that’s key.The above transcript has been edited for brevity and clarity.  More

“It’s very important that we are clear in our communication about the destination we are headed,” she told Michael McKee and Kathleen Hays in an interview with Bloomberg Television in Jackson Hole, Wyoming, where she hosts the Fed’s annual policy retreat. “We have to get interest rates higher to slow down demand and bring inflation back to our target,” said George, who votes on monetary policy this year. The interview was taped on Wednesday.Asked how high the Fed should raise rates, George said there was “more room to go” and pushed back against bets in financial markets the central bank would begin cutting rates next year. “I think we will have to hold — it could be over 4%. I don’t think that’s out of the question,” she said. “You won’t know that, I think, until you begin to watch the data signs.”Chair Jerome Powell, headlining the prestigious symposium with a speech Friday morning, is expected to restate his resolve to keep tightening monetary policy to fight inflation.The US central bank is raising interest rates rapidly to curb the hottest price pressures in 40 years. Fed officials hiked by 75 basis points at each of their last two meetings and have said the same again could be on the table when they gather next month, depending on the data. They get fresh reads on consumer prices and employment between now and then.George saw some signs of demand cooling but “certainly you’re not seeing it fully in the inflation data yet. It’s still very broad-based, and I think tells us there is more work to do.”US consumer prices rose 8.5% in the 12 months through July. The Fed aims at a different gauge, called the personal consumption expenditures price index, which rose 6.8% in the year through June.“We want financial conditions to tighten along with the direction we are moving around policy,” she said.In a separate interview with the Wall Street Journal, Atlanta Fed President Raphael Bostic said that he had not yet decided whether to back a 50 or 75 basis-point increase at the Sept. 20-21 gathering of the policy-setting Federal Open Market Committee.“At this point, I’d toss a coin between the two,” he told the Journal in an interview on Wednesday that was published Thursday. “We all, as policy makers, understand that inflation is a big problem and is a challenge that we’re going to do all that we can to handle.”(Updates with Bostic comments to Wall Street Journal in final paragraph.)©2022 Bloomberg L.P. More

Financial markets are betting the Bank of England will more than double interest rates by May next year, as concern mounts about further rises in UK inflation.The shift in expectations in the swap market — which anticipates interest rates of 4 per cent in May compared with 1.75 per cent today — are among the biggest swings in recent years. The shift in expectations, fuelled by persistent increases in forecast inflation and soaring energy prices, has been reflected in other markets. In the UK gilt market the cost of two-year borrowing for the government has risen more than 1 percentage point this month in the biggest rise on Bloomberg records going back to 1992. The market moves will be reflected in the cost of corporate borrowing and fixed-rate mortgage deals, affecting companies and households even before the BoE takes decisions on interest rates in the months ahead. Higher borrowing costs will be a further drag on UK economic activity and household and corporate finances already suffering from high energy, fuel and food prices — although City economists expect less of a jump in rates.Traders in the overnight index swap market, which sets prices based on expectations of future official interest rates, are now betting that interest rates will rise to 2.75 per cent by the BoE’s November meeting before hitting 4 per cent in May.Separately, the yield on two-year government bonds — indicating the average interest rate over the next 24 months — is now trading at 2.94 per cent, compared with 1.83 per cent just a month ago. “It’s been one-way traffic since the beginning of August,” said Matthew Russell, fixed income fund manager at M&G Investments, about the gilt moves. “The moves have been outsize.”Traders have become concerned as UK inflation has exceeded expectations almost every month this year, rising to 10.1 per cent in July. Russell said Citigroup’s forecast that UK inflation would hit 18.6 per cent next year “drew quite a lot of attention to the [short duration] gilt market and that combined with the situation in the energy markets in Europe, plus thin summer liquidity in the markets, has accounted for the sharp rise in gilt [yields]”.With energy prices continuing to put pressure on inflation, the new retail gas and electricity price cap for October to December will be announced on Friday. Analysts expect Ofgem, the sector regulator, to raise the annual cost of energy for an average household from £1,971 to more than £3,500.Traders in government bond and interest rate futures markets pushed the expectations of interest rates higher on each piece of bad news on inflation. Craig Inches, head of rates and cash at Royal London Asset Management, said the forecast that the BoE would raise rates to 4 per cent was reasonable. “I just don’t see a situation in the short term where the inflation pressures are going to get any easier,” he said.The financial market forecasts for interest rates reflect the central bank’s comments that it would be willing to act “forcefully” if it felt inflation had become embedded into company and household expectations. Economists are much less willing to bet on the BoE being so aggressive with monetary tightening. The consensus among City economists is that interest rates will peak at 2.5 per cent, but expectations are changing.

Paul Dales, chief UK economist at Capital Economics, which expects interest rates to reach 3 per cent, said market expectations had “jumped” in the past few weeks. “At this stage I wouldn’t really want to rule anything out,” said Dales. He added that while 4 per cent interest rates were not “completely implausible anymore . . . history shows that the markets tend to overdo the extent of tightening cycles. So at the moment, my hunch is that the markets have gone a bit too far”. More