Many readers are now wondering how and why the US Federal Reserve Bank (FED) miscalculated on forecasting the current global inflation. In a talk with Saigon Investment, Prof. Dr. TRẦN NGỌC THƠ discussed this issue further.
JOURNALIST: - Sir, you are one person who has studied very carefully the inflation in many countries in general and the United States in particular. Please can you give Saigon Investment readers a basic sketch as to how this situation is prevailing and to its effect on other economies.
Dr. TRẦN NGỌC THƠ: - There are many factors explaining the current rising global inflation such as broken global supply chains, warming of the jobs market, loose monetary and fiscal stimulus packages, and the recent Russia-Ukraine conflict. It is not just the FED but almost all investors and financial institutions, not only in the US but also in most economies are wrong in believing that high inflation is a thing of the past. However, if there is inflation now it is only being discussed in academia and in economic history classes, but in real life people are not discussing inflation as a main topic.
The last highest inflation in US history was in the 1970s. Current generations hardly feel anything about high inflation. Those who lived in the 1970s and experienced that inflation have also now forgotten about it and if it ever existed. This makes everyone subjective about inflation. But by the time you realize your mistake, it will be too late. Observers in the US often say that if the central banks are boringly repetitive about an issue or if there are now fewer jobs in the world, then the markets must not worry. However, when central banks make headlines in the global media, then markets must begin to prepare for a serious financial crisis.
At a recent conference in Sintra in Portugal, Mr. Jerome Powell, Chairman of FED, made some comments which made this bad scenario seem even more likely. Mr. Jerome Powell said that the new dynamics of global economy and the new geopolitical landscape are forcing them to rethink the way the FED operates, as the low-inflation environment does not exist anymore. He said that we live with different forces now and have to think about monetary policy in a very different way and forecasting inflation in a high inflation environment becomes too difficult a task. Mr. Powell admitted that they now realize how little the FED understands about inflation.
- Sir, does this mean that forecasting inflation in a high inflation environment is impossible and that the way central banks operate is also radically different in low and high inflation environments?
- This is exactly right! At the end of June, the Bank for International Settlements (BIS) published a study showing that the agents operating in a low inflation environment are completely different from those operating in a high inflation environment. When inflation is significantly low, volatility and persistence will also decrease, this is to say they will balance themselves.
So, the recent burst of inflation has taken most observers by surprise. By the end of 2020, most projections put inflation at or below the target of the FED and most central banks. Even in mid-2021, when inflation began to rise, projections underestimated the intensity or duration. The reason for this misjudgement is that inflation was initially concentrated in a narrow group of commodities, such as durable goods, food, and energy. According to the prevailing view in economics, these rallies are understood to be only one-time or temporary price adjustments caused by mismatches between supply and demand as that caused by the Covid-19 pandemic.
But eventually, inflation became more and more widespread. By early 2022, rates of service price growth became more persistent, having already exceeded pre-pandemic levels in many parts of the world. More than three quarters of countries with consumer goods have inflation above 5%, accounting for more than half of the basket of goods. By now, it turns out that the US economy will have to be moved into a high-inflation environment, but the FED has always been behind this inflation curve.
- Sir, in your opinion, has the FED made a significant mistake in its operating philosophy on monetary policy?
- There is such a possibility. The turning point is that after the outbreak of the Covid-19 pandemic, the FED switched to a medium inflation targeting mode. After the global financial crisis of 2008, the FED implemented unconventional monetary policies with packages of quantitative monetary easing. As a result, the US economy recovered impressively, and unemployment was at a record low.
But the problem is that inflation has always remained low below the 2% target. This fooled the FED to the extent that the FED believed there is always a free lunch available. They believed that inflation expectations have been so well maintained that it is possible to expand monetary and fiscal policy further without affecting inflation.
Therefore, the FED decided to switch to the framework of an average inflation. This means that in the near future, inflation may exceed the target of 2% in some years on an average over a period of two to three years, and as long as the average target of 2% is reached, it will all be fine. Under this new regime, the FED can aggressively implement monetary easing and support the Ministry of Finance to implement fiscal stimulus packages of up to trillions of dollars to support the economy damaged by the Covid-19 pandemic.
However, the problem is that this time the US economy does not have to go through a financial crisis like in 2008, but a natural disaster such as the Covid-19 pandemic. Therefore, the economic recovery tended to bounce back quickly and strongly after more than a year of the pandemic, resonating with the global supply bottleneck and trillions of dollars in monetary and fiscal easing that was pumped into the market. This has created an unexpected spike in inflation. The Ukraine conflict is just a drop in the ocean and has pushed things to move faster.
- Sir, it is a fact that the FED missed seeing the rising inflation. But in April of last year, as the Covid-19 pandemic began to cool, the American public also began to feel the inflation. Later data showed inflation gradually heating up. But the FED still insisted it was due to a supply shock and only temporary in nature. In your opinion, why does the FED always have different views from the public and researchers?
- As I said, nearly half a century of no inflation led the FED to believe that inflation expectations will hold, that no one will think about putting inflation in wages and prices. But there have also been warnings among FED policymakers about the so-called inflationary expectations which they consider a dubious concept. The public and businesses do not know much about inflation expectations. They only look at how the FED acts to speculate on inflation. If everything is on the radar screen, they will automatically trigger a bullish spiral. At that time, in order to restore order, the FED can only raise interest rates to a very high level and increase them continuously at a huge price. This warning, at least for now, seems to be turning out to be accurate.
In the past sessions within the FED cabinet, no one has debated whether to raise interest rates, tighten monetary policy, or whether the price shock of gasoline or food is temporary or permanent. Currently, there are only two schools of pessimism and optimism. The pessimistic group believes that an economic recession is inevitable. This group also implies that fortunately only the tools of the special forces in the Ukraine conflict can control the price storm, and the tools of the FED are no longer effective. However, the optimists say that America can have a soft landing. Mr. Jerome Powell belongs to this group, but people believe that like a general in battle, he must remain optimistic no matter what happens, but the situation is unlikely to be reversed unless something good unexpectedly happens.
- Sir, inflation is so high that the FED keeps raising interest rates. The US dollar is now overvalued against most of the major world currencies. One Euro is sometimes less than one US dollar, and one US dollar can give us 140 Yen, the lowest level in 24 years. How are the central banks of other countries reacting to this situation?
- I am observing the reaction of the central bank of Japan from the perspective of people living and working in Vietnam. There are currently two thoughts. The first believe that letting the Yen depreciate increases exports, and the second argue that letting the Yen depreciate any further would be disastrous, so the central bank must intervene to release US dollar reserves to buy more Yen.
Recently, however, a third thought has emerged, saying that the new development shows that the possibility of a US recession is very high, and therefore the FED may suddenly stop raising interest rates. At the same time, China's economy will gradually recover from the consequences of their zero covid policy. At that time, the US dollar will decrease in price, or at least not increase as hot as it has been in the past. So the central bank of Japan must wait with caution.
In my opinion, this should be a careful viewpoint of the people and businesses about the upcoming movements of the US dollar. Things can turn around very quickly in an uncertain world and excessive speculation or hoarding of the US dollar must be avoided.
- Thank you very much.