TRANSCRIPT
An overview of current challenges
Isabelle Mateos y Lago
Isabelle Gounin-Levy: In your opinion, what are the key areas of concern for central banks in the coming semesters?
Isabelle Mateos y Lago: There are really three groups of central banks, just to oversimplify. One group is facing inflation that is above target and, frankly, moving away from target.
But at the same time, there's an economy that is weakening. And the main central banks that are in this situation are the Fed, the Bank of England, and the Bank of Japan, with an important difference, which is that the Fed and the Bank of England are running still restrictive monetary policy and are in the process of easing, whereas the Bank of Japan is tightening from a very accommodative stance.
Then you have central banks like the ECB, which have basically brought inflation back to target and are running neutral monetary policy, but need to remain alert to downside risks, to growth and inflation, and have the potential to ease more. And you could see the Bank of Canada as also being part of that group.
And then you have a group that is fully back to inflation that is too low. In fact, even deflation in the case of the People's Bank of China, and that have to run very accommodative policy. And another central bank in that group is the Swiss Central Bank, which has interest rates back to zero.
Isabelle Gounin-Levy: Apart from the usual business cycle fluctuations, what structural changes do Central banks need to take into consideration, and how.
Isabelle Mateos y Lago: That's a really good question. And unfortunately for them, there's quite a few. The most important one perhaps is population change or workforce change. Until recently, this was primarily driven by demographics, which is a slow-moving variable, fairly predictable.
But recently, and particularly in the case of the US, there's been a big change in immigration policy that has led to a very fast and massive reduction in the foreign-born labour force. And so basically, when you have the workforce that contracts, it reduces the growth potential of the economy, which is like the maximum speed at which the economy can grow without overheating. So that's an important thing to consider.
Another one is climate change and the energy transition, which is likely to lead to more volatile inflation because there's going to be episodes of scarcity that leads to inflation shooting up. Now, when these things happen fairly rarely, the central banks can ignore these shocks. But when they become more frequent, then it could lead to de-anchoring inflation expectations and central banks may have to react.
And then the third one, which unlike the other two, is a more positive one, something that could be helpful to central banks, is artificial intelligence, which has the potential to increase productivity, increase the growth potential of economies. So, what economists call a positive supply shock. The problem is we don't know when it will materialize, and we don't know how big of a help it will be. The estimates range from a quarter percent of GDP to four percent of GDP boost over the next 10 years. So, it could help, but it would be unwise for central banks to bet on it.
Isabelle Gounin-Levy: Are financial markets being complacent, and how should central banks think about exchange rates?
Isabelle Mateos y Lago: That's another very good question. It's true that financial market conditions have been fairly supportive of global growth year to date. And frankly, that's been helpful also to central banks.
The fact that the dollar has depreciated has helped many central banks loosen monetary policy, which, again, has been helpful to global growth.
But as ever, you can have too much of a good thing. And if we were to see, you know, bubbles forming or the dollar depreciate too fast, that could be a problem. So that's definitely something to keep in mind for central banks.
Isabelle Gounin-Levy: Do you think the independence of central banks will be called into question in the future?
Isabelle Mateos y Lago: Well, we're already seeing this happening in real time in the United States. I think it's important to remember that there is a very long history of non-independent central banks, both in emerging markets, but also in developed markets.
And that's not a happy history. It's a history that leads to high inflation and lower growth. And that's why there is now an overwhelming consensus that having an independent central bank is a good construct for growth and stability. There is a bit of a wrestling match unfolding in the U.S. between the Trump administration and the Federal Reserve. And the outcome of that fight is going to be critically important for the rest of the world. For now, we're not seeing independence being challenged in other regions.
But of course, if governments of the same political inclination as the Trump administration were to come into power in the rest of the world, they might be tempted to follow down the same path. So central bank independence is not something we can take for granted anymore, unfortunately.
