Economy

The Monetary Policy Committee, led by Governor Sahap Kavcioglu, kept its benchmark one-week repo rate at 14%, in line with the forecasts of all economists surveyed by Bloomberg. The lira extended its drop after the decision and was trading 0.4% weaker at 16.4215 per dollar as of 2:01 p.m. in Istanbul.Deeply negative rates — when inflation is taken into account — have been a key driver of the depreciation, alongside a global rally in commodities prices and a drawdown in international reserves. The Turkish currency is the worst performer in emerging markets so far in 2022 with a loss of about 19% against the dollar.Little relief is in sight for the lira because the central bank remains set on an ultra-loose course. Kavcioglu, appointed as governor after President Recep Tayyip Erdogan ousted his predecessor for tightening policy too much, has signaled Turkey didn’t need to increase rates just because other central banks are doing so.Long championed by Erdogan, the belief that higher rates fuel price increases goes against textbook assumptions held by central bankers around the world. The Turkish government is supportive of Kavcioglu’s low-rate policy to boost growth, especially with just over a year left before elections.What Bloomberg Economics Says…“Tightening policy isn’t politically viable, despite all indicators pointing to an economy in need of higher rates. The lira could, again, pay the price for this policy error.”In place of higher rates, Turkey has relied on backdoor interventions and the introduction of state guarantees for some bank accounts to shield depositors from lira weakness. Until now, the approach ensured a period of stability. Kavcioglu has said consumer price growth, currently at a 20-year high of nearly 70%, could start slowing as early as June and disinflation will gather momentum at the end of the year.But inflows into the so-called FX-protected accounts have slowed in recent weeks and the central bank’s reserves are down sharply, leaving it with a small backstop to support the currency. Excluding swaps with commercial lenders and other central banks, Turkey’s net foreign assets have reached negative $63.3 billion, according to Goldman Sachs Group Inc.The existing policies have also done little to address the causes of a sharp deterioration in domestic confidence that has weakened the lira. As inflation spirals higher, public discontent over the management of the economy is rising.For investors, Turkey’s standoff with its NATO allies is another drag on the country’s assets. And with commodities prices soaring after the Russian invasion of Ukraine, Turkey’s current account is falling into deeper deficit, further pushing up demand for foreign exchange.The selloff has by now pushed the lira to the weakest level since a round of rate cuts contributed to its rout late in 2021. It has breached past 16 per dollar and is now at risk of weakening to 19 per greenback by the end of this quarter or soon after, according to Cristian Maggio, head of portfolio strategy at TD Securities in London.“The dire state of Turkey’s macrofinancial conditions” — from inflation to the current-account deficit and deeply negative real rates — “spells disasters to come for the lira,” he said before the latest decision.©2022 Bloomberg L.P. More

When corporate bosses descended en masse upon Glasgow for COP26, many observed — often with discomfort — that it felt something like a Scottish edition of Davos. Six months on, many of those same faces are here in the real Davos for the World Economic Forum, talking a good game on climate action in both private and public conversations. But how much progress are they making on realising the lofty pledges many of them made in Glasgow?I discussed that yesterday with Nigel Topping, who helped to pull together those private sector commitments at COP26 as the UN climate action champion, and is now working on preparations for this year’s COP27 in Egypt. It is still early to make a hard call, he said, pointing out that corporate signatories to the UN’s Race to Zero initiative have until September to lay out hard plans to reach carbon neutrality.But there were worrying signs of backsliding in some quarters, Topping said, amid calls for new investment in oil and gas as the Ukraine conflict drives surging energy prices. “Nothing scientifically says we need more gas,” he said. “The most disingenuous thing is to suggest that a starvation of investment in hydrocarbons has caused the current energy crisis.”And for all the bold words from government and corporate leaders here in Davos, he said, there is still a “big gap” between promises and hard policy that will need to be closed fast for serious progress to made in Sharm el-Sheikh.You will find more on the climate debate in Davos below, along with the latest on the push for global sustainability reporting standards, and the lowdown on a hectic day of shareholder votes in the US. We will be back in your inbox tomorrow. (Simon Mundy)Davos day 3 in briefPakistan’s foreign minister told the FT that the country wants to renegotiate a deal with the IMF, citing worsening economic circumstances. “This is a pre-Afghanistan situation deal, this is a pre-Ukraine deal, this is a pre-pandemic deal and pre-current global economic trends.”Pfizer’s chief executive Albert Bourla warned that growing complacency on Covid-19 will cost lives. “I feel . . . people are ready to compromise and lower the bar: maybe we can accept a few more old people dying,” he said.IMF deputy managing director Gita Gopinath said there was no evidence yet of a systemic sovereign debt crisis — but warned that the risk ahead was “salient”.WTO head: Rich world has ‘no excuses’ on climate finance failureOn a day thick with climate discussions at Davos, perhaps the most noteworthy remarks came from Ngozi Okonjo-Iweala, director-general of the World Trade Organization.The former Nigerian finance minister delivered a swingeing attack on the failure of developed nations to meet a pledge to provide $100bn in climate-related financial assistance to developing countries, contrasting it with the firepower they rolled out domestically in response to the Covid-19 crisis.“There was a pandemic and we suddenly saw $14tn . . . money coming out of everywhere,” she said. “It was the right policy response. But then it has bred scepticism. If the developed countries could come up with that amount of money in a short amount of time, what’s $100bn compared with $14tn? Why can’t we come up with this money? There are no excuses on this.”Okonjo-Iweala renewed her call for an international carbon pricing system — something that she said could be developed under the WTO’s auspices.Her remarks followed a session earlier in the day that grappled with the problem of how to hit the global goal of net zero carbon emissions by 2050. UN climate envoy Mark Carney added his voice to those warning against an excessive focus on divesting fossil fuel assets. “This is about real-world decarbonisation, not the false comfort of portfolio decarbonisation,” he said. “The easiest thing to do is to sell and walk away, make it somebody else’s problem.”

Anne Richards: ‘ . . . if you go back five years, the ESG agenda was a niche’ © Bloomberg

Anne Richards, chief executive of the $800bn asset manager Fidelity International, said that there had been a dramatic shift in her sector’s approach to climate issues, with most clients now keen to ensure their investments help tackle the problem. “It’s almost never that you don’t have sustainability raised as part of that conversation — whereas if you go back five years, the ESG agenda was a niche.”But a far more sceptical take on the financial sector’s transformed thinking came with a session of young climate activists, who condemned a continuing failure by corporate and political leaders to turn rousing words into action. Ecuador’s Helena Gualinga hit out against the oil companies that she said have been having a devastating impact on her Kichwa Sarayaku community — and the financial companies who continue to fund such projects.“Many, many big banks and financial institutions work directly with these companies,” she said. “Even though they’re not harming with their own hands, they’re complicit in the harm that is being done.” (Simon Mundy)Faber seeks to calm jitters on ISSB standardsThe International Sustainability Standards Board is planning to develop its new framework in a way that is practical and proportional, its chair Emmanuel Faber pledged in Davos on Wednesday.Faber promised to make the standards as streamlined and simple as possible. “We will be pragmatic,” the former Danone boss said, noting that it would be inappropriate to expect small companies to adhere to the same standards as global giants.The comments come as the issue of accounting has sparked extensive debate in Davos in private meetings and panels, since many global giants are not only racing to implement their own frameworks and metrics — but increasingly demanding that their own suppliers do this too. The recent initiatives from the SEC and European Commission have sparked particular discussion, since many corporate leaders have reservations about some of their measures, and are urging them to water them down. There is also dismay among some finance chiefs and chief executives that they are likely to need to adhere to three sets of standards in the future — from the SEC, EU and ISSB. However, nobody doubts the direction of travel, and many say that clearer frameworks could help reduce the charges of greenwashing and the risks that the SEC’s recent action against BNY Mellon has highlighted. “Words like ‘pragmatic’ and ‘proportional’ are what we want to hear,” the finance chief of one large bank told Moral Money. Whether green activists will agree, however, remains to be seen. (Gillian Tett)Quote of the dayJeremy Raguain, a fellow at the Association of Small Island States, warned a Davos audience that vested corporate interests still wield disproportionate clout over the climate-related policies of governments in large economies. “The science is clear, but there are many well-funded lobbyists,” he said. “Who’s in the room when the science is being fought over to make policy?”Elsewhere in ESG: Climate activists score wins at company meetings

Eight demonstrators were arrested at BlackRock’s annual meeting on Wednesday © Bloomberg

While demonstrations against BlackRock’s fossil fuel holdings on Wednesday were not as raucous as the protests at Shell earlier this week, eight people were arrested outside the asset manager’s Manhattan office as shareholders took part in the group’s annual meeting, activists said. Inside the meetings, shareholders endorsed agitation at companies to move faster on climate progress. On one of the biggest days in the US for annual meetings, a majority of ExxonMobil shareholders supported more disclosures about how it is affected by the International Energy Agency’s net zero 2050 models. More than one-third of Exxon shareholders also supported a report about the company’s efforts to reduce single use plastic.Shareholders at Chevron pressed the company to move faster on climate change. Thirty-nine per cent of shareholders voted for a full accounting of the company’s climate risks.“With this strong vote, investors have made it clear that companies must fully address how the global transition away from fossil fuels will affect their companies’ bottom lines and future success,” said Danielle Fugere, president of As You Sow, a non-profit that sponsored the proposal.In Silicon Valley, Amazon came up against a record 15 resolutions on environmental issues and workers’ rights — all of which were voted down by investors. But shareholders at Twitter voted for a petition demanding the company publish its political spending to lobbying organisations and other causes. The company has said it does not do political giving, but it has received low scores for political transparency. While the final chapter on the annual meetings season has yet to be written, companies have faced fire from investors when they have been unwilling to concede to demands before a vote. (Patrick Temple-West)Smart readMining company Glencore is set to shell out $1.5bn to settle charges of bribery and market manipulation. Two of its subsidiaries will plead guilty to corruption charges. It’s yet another stain on the company’s troubled reputation. But is it good news for shareholders? More

His comments to thousands of local officials at an emergency meeting Wednesday were more frank than the official readout published by state media.Li told attendees that economic growth risks slipping out of a reasonable range, according to people familiar with the discussions. He said China will pay a huge price with a long road to recovery if the economy can’t keep expanding at a certain rate. That means growth must be positive in the second quarter, he said, according to the people, who declined to be identified in order to discuss official matters. The remarks reinforce economists’ expectations that the government’s growth target this year of about 5.5% is increasingly out of reach. Beijing is holding steadfast to its Covid Zero strategy of lockdowns and other restrictions, which have brought activity in major hubs like Shanghai to a standstill. Economists surveyed by Bloomberg now expect the economy to grow just 4.5% this year, with some, like Morgan Stanley, downgrading growth to as low as 3.2%.Li listed a handful of objectives for local officials to focus on this year, including better balancing Covid controls and economic growth. He also urged those authorities to earnestly carry out policies the government has introduced in recent months to ensure economic stability. Growth is the key to solving all problems in the country, such as creating jobs, ensuring people’s livelihood, and containing Covid, he said.Here are some of the key highlights from Li’s meeting which weren’t reported by the official state media, according to people familiar with the discussions.UnemploymentLi said the spike in the jobless rate — it hit 6.1% in April, close to a record — would bring about grave consequences. While jumps are tolerable in the short term, he warned dangers would emerge should the problem last longer than a quarter. That concern, he said, means that economic growth must be positive in the second quarter, and the unemployment rate must drop.Local FinancesLi made clear to local authorities that their economies need to recover so they can generate income, adding that all aid the central government can provide has been included in the budget and it only reserved some funds for the handling of extraordinary natural disasters. Local governments need to support the resumption of work as Covid gets under control.InflationLi also stressed the need to ensure grain output does not fall below last year’s levels, as such production is key to keeping inflation in check. He told local governments to make sure summer harvesting and stocking is conducted smoothly — meaning the harvest can’t stop even if there is a Covid outbreak. Local officials will be held accountable if they can’t stabilize grain production, he warned, adding that it’s their basic responsibility. EnergyThe premier told officials to keep coal mines in operation as long as they meet work safety this summer, adding that energy would be in short supply no matter the state of the economy. Power cuts cannot happen, he added. Li also highlighted the importance of manufacturing in China, which he said was a mainstay that employs as many as 300 million people, unlike developed countries where service industries make up the lion’s share of the economy. The industrial chain must be protected, he said.©2022 Bloomberg L.P. More

The global elite gathered at Davos this week for what by all accounts has been a gloomy affair. The head of the IMF, Kristalina Georgieva, set the tone by warning against “geoeconomic fragmentation”. Among business leaders the talk is all about globalisation going into reverse. So here, in the spirit of constructive contrarianism, are some ideas to sprinkle a little nuance over the debate. Fragmentation? What fragmentation? So far, the curious thing is that fragmentation can, as Robert Solow quipped about productivity, be seen everywhere but the statistics. Start with trade, which has grown strongly from the short-term collapse in the early months of the pandemic. As the chart below shows, until the first quarter of this year merchandise trade gave little indication of deglobalisation for rich countries, China, or the 20 biggest economies (advanced and emerging) taken together. Indeed the IMF’s own research shows that the world now trades more than it had projected three years ago. For all the disruptions, real as they are, cross-border supply chains have delivered greater exports than was expected of them. Just not enough to satisfy the gargantuan shift in US (and mostly just US) consumer demand from services to goods, which is what started our current inflationary burst.We can make the same observation about financial globalisation. Banks’ total cross-border liabilities peaked in 2008 as the global credit boom turned to bust (see the chart below). But since about 2016 cross-border entanglements have been rising quickly. They admittedly came down a little bit in the past year but remain near peak levels.Of course, the world has changed since the first quarter of this year. The monthly World Trade Monitor database shows trade growth stagnated in March (but also that the momentum of world goods trade was strong until February). But does this reflect fragmentation? Of course, Russia is being cut off from global economic activity, as it should be, and more comprehensively than has happened to date. The World Trade Monitor estimates that Russia’s imports collapsed by 40 per cent from February to March. And Ukraine is having much of its trade shackled by Russian president Vladimir Putin’s assault, which beyond the sheer violence of his warfare ranges from blocking the country’s ports to stealing and destroying grain in a macabre echo of the famines engineered by Stalin in the 1930s. Apart from that, however, trade may be flat but is hardly unravelling. The slowdown in March is largely driven by China, which has had its coronavirus lockdown challenges to deal with. And the world economy as a whole is palpably slowing down, so it is natural for trade to slow as well (the World Trade Monitor estimates that world industrial production fell 1 per cent in March, much more than the 0.2 per cent fall in goods trade). But that is an effect of the economic cycle, not the level of cross-border integration.Deglobalisation does not produce resilience. Even if fragmentation exists largely as a threat in the minds of the Davos Men and Women, that is not to say they are wrong to be worried. There are clearly political pressures to reverse globalisation. These existed before the pandemic and Putin’s war but were strengthened by how these revealed just how economically interdependent we were.As I wrote early in the pandemic, however, resilience to shocks and autonomy from geoeconomic pressure can be assured not just by self-sufficiency, but also by a combination of stockpiling and diversification. And both of those are easier to achieve when you can source from many countries and not just your own. If the worry is being held economically hostage by hostile governments, this can be addressed not by trying to “reshore” all your supply chains but by reorganising them around the economies of allied countries — what US Treasury secretary Janet Yellen calls “friend-shoring”.If, instead, you pursue resilience through self-sufficiency, you risk ending up with neither. The scandal of baby formula shortages in the US has just served up a perfect example of this, as my colleague Brooke Masters explained in a recent column.There is fragmentation and there is fragmentation. Globalisation means two things. Conceptually it means the economic integration of national economies — deepening cross-border flows of goods, services, capital and people — especially between countries at different levels of economic development. But sometimes it is taken more literally to mean this process involving the whole world. Bear this in mind and you can see that it is possible to “deglobalise” (in the latter sense) without “deglobalising” (in the former sense). Yellen’s friend-shoring is an illustration of this.There is a lot of pressure to friend-shore. Look no further than the EU’s plan to reconfigure its energy system. It aims to end energy imports from Russia, but it does so in part by intensifying other regional and global trade in energy, in particular finding new suppliers for imports of natural gas today and hydrogen in the future. Look, too, at the efforts among democracies to agree rules of the road for the digital economy and the handling of sensitive data, which may lead to fewer digital transfers between democracies and non-democracies while deepening data connectivity within these blocs.So it looks very plausible that the global economy may be reorganised along big regional blocs defined not just by geography but by common values and governance. That would be “deglobalisation” in the literal sense. But it would involve more globalisation in the economically meaningful sense — that of deepening cross-border economic integration. “Regionalised globalisation” would be a better term.The question, then, would be whether further globalisation within such regional, politically delineated blocs could be as efficient and productive as a literally global integrated economy. My hunch is that for the advanced economies centred on the transatlantic west, the answer is yes — and that there is much more doubt for less advanced economies. But that is, to be sure, an uncertain gamble. If regionalised globalisation is the way we are headed, we shall find out whether China needs the west more than the west needs China.Other readablesIn my FT column this week I explain why the EU’s new plan to reconfigure its energy system away from dependence on Russia is a good one — but that more fresh money is needed. Sylvie Kauffman sets out how two schools of thought have emerged in Europe on what victory against Russia in Ukraine should mean.Numbers newsOutput shrank in the first quarter in the G7 biggest advanced economies taken together. All OECD countries together only managed to grow by 0.1 per cent.And this week’s purchasing managers’ indices indicate that UK economic activity is screeching to a halt. More

Government bond markets have clawed back part of this year’s heavy losses in recent weeks as investors’ attention shifts from sky-high inflation to signs that economic growth is slowing. Bonds have endured a painful year so far as major central banks rush to contain runaway price rises by embarking on a rapid tightening of monetary policy. But longer-term government debt — an ultra-safe asset which tends to benefit from fears over the health of the economy — has steadied in recent weeks as a sell-off in riskier assets like stocks accelerates.A Bloomberg gauge of long-term US government bonds is on course for a third consecutive weekly rise, gaining more than 4 per cent since May 6, a turnround echoed in European markets. Although the recovery remains modest compared with the scale of earlier declines — the index is more than 18 per cent lower year-to-date — some investors sense a turning point for the heaviest global bond sell-off in decades.“We have rarely been as bullish on government bonds as we are now,” said Mike Riddell, a senior portfolio manager at Allianz Global Investors. “If growth slumps, then inflationary pressure will recede, and yields look more attractive than they have in a long time.”The US 10-year government bond yield — a benchmark for financial assets around the world — has fallen to 2.71 per cent from a high of 3.2 per cent two weeks ago. On Thursday, it reached the lowest level since mid-April. The equivalent German yield has also declined, from nearly 1.2 per cent to 0.96 per cent.

Even though the Federal Reserve is still in the early stages of raising interest rates — while the European Central Bank has yet to lift borrowing costs from record lows — the anticipation of aggressive policy tightening has already had a big impact on markets and the economy, according to Riddell, who cited the example of a drop in US home sales as mortgage rates surge.“Over the past month, we went from inflation woes dominating to recession fears increasingly being the cause for concern,” said George Goncalves, head of US macro strategy at MUFG Securities. “It’s possible that we have hit the cycle high for the [US] 10-year yield and it’s more likely we continue to slide lower in long-term rates into the summer months.”While inflation in the US remains close to its highest level in decades, market expectations of longer-term inflation have begun to ease. The five-year, five-year forward break-even rate — which is a gauge of inflation forecasts over five years, five years from today — fell on Wednesday to 2.2 per cent, its lowest level since March 1. It had reached an eight-year high in mid-April. In the US, evidence of an impending slowdown has mostly been seen in company earnings reports — like that of retailers Walmart and Target, or social media group Snap’s growth warning this week. But the economic data may be starting to turn. The S&P purchasing managers’ index on Tuesday showed business activity in the US, the UK and the EU all falling in May. More

Apple will increase pay for its workers in a bid to deal with inflationary pressures, unionisation efforts among employees and increasing competitiveness in the labour market.The iPhone maker told staff on Wednesday that the hourly pay for US retail workers would rise to $22 per hour or more — up 45 per cent from 2018.Rates outside the US, as well as starting salaries, are part of the planned increases but Apple declined to provide any details or disclose the size of its overall compensation budget.The company will also pull forward some annual increases to July rather than in the autumn.“This year as part of our annual performance review process, we’re increasing our overall compensation budget,” Apple said.Apple announced the changes a week after a similar initiative from Microsoft. The iPhone maker’s plans were first reported by the Wall Street Journal.Labour shortages coupled with the fallout of the coronavirus pandemic and homeworking trend have resulted in a strengthening of the worker’s moment in the US, with staff more willing to challenge employers and push back against policies to force them back to the office.Apple staff have become increasingly vocal about working conditions at a number of its US stores, including the Grand Central location in New York, and have begun the process of forming unions.The workers have launched a website called Fruit Stand Workers United to collect signatures and demand “better wages, benefits, and working conditions from Apple”.Employees have cited the impact of Covid-19 and “once-in-a-generation consumer price inflation”, which has hit a 40-year high of 8.3 per cent in April.Apple Store workers said they were galvanised by successful efforts at Starbucks, where staff at dozens of stores in at least 19 states have taken steps to form unions.

Greg Selker, managing director at law firm Stanton Chase, said the pandemic had “supercharged” multiple trends contributing to both workers and corporations re-examining pay, benefits and the use of physical spaces.“All of these factors have led to a shift in the balance in terms of hiring and seeking new employment, where the power is now much more in the hands of the sought-after employees than anywhere else,” he said.Amazon has also been under pressure. In December, the National Labor Relations Board required the ecommerce giant to post public notices telling employees they had the right to organise with colleagues without interference. More

The writer is chief economist at the Institute of DirectorsIn normal times, the Bank of England would go out of its way to avoid a recession, and not just because of the human cost. The “symmetric” nature of its inflation target means it is as concerned about undershooting as overshooting.In a high inflation environment, however, such concerns are jettisoned. With shortages on the supply side — energy, superconductors, staff — it’s the simple laws of supply and demand that drive prices up. Given we can’t fix those any time soon, the only other option is to reduce demand. This is a tough love message: no wonder therefore that global equity markets have gone into a jitter as they try to process its implications.Facing this situation, what the UK economy needs most of all is a moment when people believe inflation is peaking, and so will soon start to fall. Not only will that reassure central bankers that they don’t need to prioritise prices over steady growth, but it could also prove self-fulfilling if it calms expectations and so lessens the likelihood of factoring rising prices into every business decision.As recently as January, the expectation was that inflation would peak in April when the household energy price cap was raised. Now, surveys of Institute of Directors members suggest it will be much further into the future. The irony is that the price cap, designed to protect consumers from volatile energy markets, is now delaying the moment at which people think we are through the worst.For policymakers, however, this delay is also an opportunity, as it gives them time to decide on the nature of their response. So why not intervene on household bills in a way that directly reduces inflation? That would help persuade business and consumers that we are through the worst and therefore change behaviour. It’s a policy win-win: supporting vulnerable households at the same time as changing the inflation narrative.This means the much-anticipated intervention by chancellor Rishi Sunak should address the root cause of the problem, namely the energy bill itself. This is what is in the basket of goods used to calculate consumer price inflation. One option would be to reduce the rate of VAT on fuel but this is ill-targeted and potentially of limited impact since it can only be cut from the current rate of 5 per cent to zero. A better option would be to ramp up the support offered by the existing Warm Home Discount scheme, through which people on lower incomes apply to have their bills reduced. The government has recently decided to expand the scheme and make the payments automatic. This means much of the preparatory work has already been done.In order to affect CPI, the subsidy to bills should be broad-based but could simultaneously be progressive. The scheme as currently designed has two groups based on differing needs; the most vulnerable could therefore receive more support in recognition that energy bills make up a higher proportion of their total household expenditure. It would also need to be directly funded from the Treasury — presumably from the proposed windfall tax — rather than being cross-subsidised from other bills.By convention, Bank of England inflation forecasts do not take account of policy announcements that have not been officially made, even if they appear likely. However, if the chancellor announces his intention to reduce the actual bills that households will pay with the explicit aim of putting downward pressure on CPI, that would affect the official forecasts. In that way, by tackling the root cause, policy intervention can contribute directly to the sense that we are over the worst, which then in turn will start to improve the overall economic environment to the benefit of us all. More

This is part of a series, ‘Economists Exchange’, featuring conversations between top FT commentators and leading economistsIn an Economists Exchange published just over a year ago, I discussed the risks of an upsurge in US inflation with Larry Summers, former US Treasury secretary. Summers, a staunch Democrat, criticised the Biden administration for the scale of its fiscal stimulus, which would, he feared, lead to significant overheating and then inflation. Subsequent events apparently vindicated his worries. Olivier Blanchard is among the world’s most respected macroeconomists. Of French nationality, he has been professor of economics at the Massachusetts Institute of Technology and chief economist of the International Monetary Fund. He is currently a senior fellow at the Peterson Institute for International Economics in Washington, DC. He was one of the leading figures in the creation of “New Keynesian” economics in the 1980s and 1990s. More recently, he has argued that low long-term interest rates mean that it is safe to run larger fiscal deficits than previously thought. Yet, in February 2021, he, too, warned of the threat of inflation, also stressing the excessive fiscal expansion. So, that is where our discussion began.Martin Wolf: You were one of the people to warn that inflation was coming. Why did you think this? And have you been proved spectacularly right?Olivier Blanchard: I thought it obvious at the time that the amount of spending — the $1.9tn size of that bill, which came on top of a bill of nearly $900bn a few months before — was just too large. It was fairly obvious that this would lead to overheating of the economy. And, where I was partly right and partly wrong is that I had this notion that unemployment would get very low, which it did, that there would be wage pressure and that prices would reflect the higher wages and that this would lead to more inflation. But I didn’t anticipate the role of the goods market, which is that in many sectors the strong demand led to supply disruptions and very large increases in prices. In the end, inflation came first not from where I would have expected it to come, which was wages, but rather from prices. People will say, these were accidents that could not have been anticipated, so you don’t get any points for your forecast. But I think that the increase in prices, the disruptions in supply chains, are very much the result of strong demand hitting supply walls. So, I would claim that I should get a few points for being right in February or March of 2021. Anybody could have come to the same conclusion. I’m happy I did. And then I would admit that inflation has been even higher than I expected, due to this problem in the goods market. A bit of boasting and a bit of humility.If people did not have the money, they would not have spent it on anything, whether goods or services. But given that they had the money, they spent more on goods than on services. So, that aspect of things, yes, I had not anticipated it. But, if I had known it, then I would have been even more cautious about policy.MW: In your story fiscal policy is the decisive element. But what about monetary policy? The Federal Reserve insisted until last November that these price pressures were transitory and would soon disappear. Now it is playing catchup.OB: The question is: what should the Fed have done or said when the fiscal package was passed? I hope that Jay Powell picked up his phone and told the administration that this was going to be an issue. His staff drank the Kool-Aid, and he, not being a professional economist, could not easily second-guess them. They thought inflation expectations would remain anchored and that the Phillips curve [which shows the relationship between unemployment and wages] was flat. So, even if there was overheating, which some of them predicted, it would not have much effect on inflation.Even at the time, I argued that the reason expectations had been so stable and the slope of the Phillips curve had been so small was 20 years of no need for action — and so no action. But I think the staff convinced itself, convinced the Board and convinced Powell. So, that’s at the beginning.

If you look at the meetings and press conferences of the Federal Open Market Committee since the middle of 2021, Powell has been a bit more pessimistic each time, and he has been even more strongly pessimistic in the past few months. So, I think he had a sense that more was needed.They have indeed been playing catchup. But there was a question of how and at what a rate you deliver the bad news.MW: Do you think that we are talking about a US story, not a developed country story more broadly?OB: The question is where does advanced economy inflation come from, and my sense is that it largely comes from the US, including the effect of the US on commodity prices. If the US had been more careful, there would have been a much smaller increase in commodity prices. We are focusing on commodity prices at this stage, because of Ukraine, but the rise had largely happened before the war and I think you have to trace it mainly to very strong demand from the US.The reason I was pessimistic for the US until recently and still think that we will see a tougher scenario than is now expected is that there’s one set of forecasts which will not happen with probability one — those in the Fed staff forecasts of March. In these, they had unemployment staying at 3.5 per cent throughout the next two years, and they also had inflation coming down nicely to two point something. That just will not happen.So, what will happen is, either we’ll have a lot more inflation if unemployment remains at 3.5 per cent, or we will have higher unemployment for a while if we are actually to get inflation down to two point something. Clearly, some of the inflation is going to go away on its own. But it will not get back to anything close to 2 or even 3 per cent at that low unemployment rate. So, more action will be needed. And then the big question is, how strong will aggregate demand be in the US? For the moment, the economy is running extremely hot and the vacancy rate is at levels that have never been seen before. But could a recession come without the Fed doing anything more than it intends to do? It’s not inconceivable.One point concerns the poor GDP numbers for the first quarter. Now, it’s directly due to export and imports, not consumption or investment. But why did it happen? I don’t know, but if it continued, it would decrease growth. There is also an enormous fiscal consolidation right now. This will clearly decrease demand, regardless of monetary policy.Yet the reason it’s not obvious that there’ll be a decrease in demand is that there was this enormous accumulation of savings and it’s largely not yet spent. Also, the states received a lot of money in the $1.9tn fiscal package. They haven’t spent much of it either.

Maybe somebody smarter than me could decide how it’s going to play out, but it is not inconceivable that the economy will slow down on its own quite a bit. Unemployment would then increase, and this would decrease the pressure on inflation.And in this case, maybe the Fed would not need to increase its rates much above 3 per cent. If this did not happen, then 3 per cent nominal interest rates with expected inflation above 3 per cent would not strike me as sufficient to slow down the economy and decrease inflation. So, that’s where I am on the US.MW: Another factor, I suppose, and you touched upon this one, is what’s going on in the financial markets. There’s a worry that the economy might tank because there’s just so much market turmoil. OB: When you say there is turmoil in financial markets, what I see is that there is a large decrease in stock prices and an increase in interest rates.That’s how the monetary mechanism works. I should have added this to the list of things that might slow the economy down. It’s monetary policy working via market anticipation of higher rates to come. Is this going to lead to financial trouble? I’m not a specialist in financial balance sheets, but what I read from the stress tests and other studies is that the financial system can take it. If financial markets cannot take it, or if governments complained, would the Fed or any other central bank say, okay, we give up and we won’t increase rates? My sense is no. As long as people like Powell are in charge of the Fed, or Lagarde in charge of the European Central Bank, that’s not an issue.MW: You are associated with the argument known as “secular stagnation”. Is anything happening now leading you to qualify the basic story, or do you take the view that what we’re seeing is essentially a blip caused by the shock of Covid and an inappropriate monetary and, above all, fiscal response to it? OB: That’s the $1tn question. Your question is, indeed, how much of this is a blip. I use the word bump, which I think has a slightly longer length than a blip. But I believe we will then go back to low real interest rates.So, on this, I’m going to do the Larry Summers thing. I am going to say, with probability 0.9, we’ll return to something like that world. I think there’s a tendency for markets to focus on the current, on the present and extrapolate it forever. But if I look at the factors behind the decline in real interest rates since the mid-1980s, none of them seems about to turn around, except perhaps one, which is investment. Suppose that there were a large increase in public investment in the US, because we’ve realised we have to do something about global warming and in Europe, for the same reason. So, this would increase investment. That would increase the neutral real rate of interest.So, I can think of a new world in which public investment, and perhaps private investment as well, is much higher in the US and Europe. How high? I don’t think terribly high. But I would distinguish between the fact that we’re going to have a period of higher real rates, to slow down inflation, and the question whether we then go back to the same low real rates as before or a bit higher ones. On the latter I’m agnostic.MW: Let’s move, now, to the European situation and relate it to the war in Ukraine. If you look at eurozone core inflation, it’s gone up a bit on the standard measures, but not very much. So nothing like the US. Given the history and the situation, was the ECB right to contemplate tightening before the Ukraine war? OB: I think so. They said they would slowly tighten. I thought, at the time — this was February — that this was a reasonable course. Inflation was largely imported into the eurozone, while labour markets were not as tight as in the US. So, I thought that it was a reasonable course of action. The question is what should the ECB do now. I think there are two opposing forces at work. The first one is that Europeans seem to be quite relaxed about inflation, thinking it will just go away. And indeed, it might have gone away, had the war not happened. If inflation continues to be so high, there must be a concern about the “de-anchoring” [shifting upwards] of inflation expectations. Other things being equal, that would force the ECB to be tougher than it would otherwise be.The factor that goes in the opposite direction is that the US is self-sufficient in energy and food, while Europe is self-sufficient in food, but not in energy. We don’t exactly know how much prices will rise as a result of the Ukraine war, but on the assumption that it has caused a 25 per cent increase in the price of energy, that will lead to a decrease in EU real incomes of roughly 1 per cent. This is likely to have an adverse effect on demand. So, this says the European economy might slow down on its own.

At this stage, it seems to me, the two factors are of roughly the same strength. But I would wake up every day if I were Christine Lagarde and look at the new numbers and be ready to move one way or the other.Okay, so interest rates are going to increase in the eurozone. I have no doubt about that. But, more importantly, spreads are also increasing: the Greek 10-year spread has increased by 93 basis points so far this year, and the Italian by 67 basis points over the same period. That could put the ECB in a difficult situation. Their position has been that if the rise in spreads is not due to fundamentals, but just to markets becoming dysfunctional or crazy for some reason or another, they would do what it took to keep the rates low. But if it were due to fundamentals, they say, it’s not something they could deal with. So, what are they going to do if the spread on Italian bonds, say, goes up by another 100 basis points? Is it fundamentals? Is it really a worry about Italian debt, or is it just investors being edgy? It’s going to be very difficult if the ECB is faced with a large increase in spreads, because the only way they could do the right thing would be to say, well, we think its fundamentals are fine and we think investors are wrong.That’s really hard for the ECB to do. My sense is that the assessment of whether it’s due to fundamentals or is just noise should be left to somebody else — the European Stability Mechanism, for example. You choose your institution, but that looks to be the right one. And then it would send signals, saying, “no, we think that Italy is not in such trouble.” And then the ECB could continue to buy Italian bonds or keep Italian bonds.But that may well come as an issue in the next six months, and I don’t think that the ECB is in a position to do what it would need to do.It’s fascinating, this worry of investors, with respect to Italy, for two reasons. The first one is, Mario Draghi is in charge. He is not in charge forever, but he is in charge, and this is not exactly a crazy man, right. And the second is, because inflation is so high in Italy, the debt-to-GDP ratio will almost surely decrease substantially this year and next year. Worrying about the stability of the debt in Italy in the current context strikes me as rather strange. MW: The war has created some very big dilemmas in terms of how to do sanctions and how to bear the impact of sanctions on the European economy. And of course, some economies are much more exposed to exports of Russian gas, in particular, than others. Italy and Germany are very exposed. France, much less so.Do you have your own view on what Europe needs to do in the short, medium and long runs to handle this set of potential crises and the trade-offs involved?OB: Yes, I came out with a paper with Jean Pisani-Ferry on that. I have a sense that the implications may be much bigger for the long run than for the short run. I am struck by how this is going to change Europe in ways that also matter for the economy. I think somebody said “we are in a world of deglobalisation, but the implication might be that we’re going to get a more European globalisation”. I very much agree. I think that may strengthen the links within Europe. We’ve learnt that many of the major decisions must be taken at the EU level. So, I think it has strengthened Europe enormously.Now, coming to the short run, the main economic effect is on energy and food prices. I also don’t think we should take as given that the price increases we’ve seen are going to continue. They might reverse if there is a recession in China. But for the moment the main issue is energy prices. It’s much better to go after Russia on oil than on gas. And the reason is fairly simple, which is that if we put a tariff on oil from Russia, then Russia will not sell us oil because it would have to take the decreasing price to offset the tariff. So, it’s going to look for other markets. We know that China is willing to buy some, India is willing to buy some and so on, but they are not willing to do it at the normal world price, and shipping companies are not willing to deliver the Russian oil at the usual price either. So what we would see is a decrease in the price of oil to other markets: the “Ural” price of oil has a discount of about 35 per cent.

In that scenario, I think what happens is that Russia continues to sell what it can, but accepts a decrease in revenues of 35 per cent, which is substantial. But the world supply of oil doesn’t change very much, and to a first approximation, this gets you a decrease in Russian revenues without much of an increase in the price of oil worldwide.For gas, it’s more complex, because when we put a tariff on gas, it may well be that Russia increases its price. And here, I think, the cross-country distribution issues also make it harder to manage.Russia is a small player in a rather competitive market, worldwide, for oil. But in the case of gas, they’re facing an incredibly inelastic demand for gas. It’s clearly less elastic than in the standard monopoly condition, which is that the elasticity of demand has to be at least, greater than one, since otherwise the supplier could impose an infinite price. The reason Russia has not done this is that if it chose an extremely high price, that would increase revenues in the short run, but it would decrease them in the long run as demand and supply adjusted. Russia faces this inter-temporal trade-off. That’s the reason the price of gas from Russia has not been incredibly high so far. But since it’s likely Russia will not be able to sell gas to the EU in the future, and because it needs more revenues now, I think it has an incentive to substantially increase the gas price. We shall see.The long and the short of it is that we should be very aggressive on oil, but more careful on gas. In terms of revenues, oil revenues are also much larger than gas revenues, so I think that’s the way to go. The above transcript has been edited for brevity and clarity. More