Leonardo Badea (BNR): Global challenges emerging from the new economic reality

“In the international economic and financial environment, are still strong the echoes of the latest discussions between the representatives of the main central banks of the developed countries, at the yearly event hosted by the US Federal Reserve in Jackson Hole. The main elements that have attracted attention are related to the determination of both the European Central Bank and the Federal Reserve for the actions aimed at tempering inflation and bringing it back, eventually, close to the target.

The firm tone of the statements met the expectations of the market and still holds the front page of specialized publications, being the favorite subject of comments and opinions of economic analysts. However, I believe that it should not come as a surprise to anyone, for many reasons that have been discussed at length previously: the need to strengthen the credibility of central banks, the developments and information available in recent quarters that clearly demonstrated the persistent nature of inflation in opposition to the expectations that could be formulated on the basis of previously available data, the risk of unmooring the expectations and the increasingly significant observation of their harmful effects on the functioning of the economy, etc.

Therefore, I would not refer to these statements, but instead I would try to bring back to the fore, very briefly, several other nuances of the opinions expressed by renowned economists and some global concerns reiterated in the statements of the last days that did not hold the front pages of the newspapers, but which, in essence, are at least as important for our future and for the entire international community, both from an economic and financial, as well as a social perspective. They are complementary to the Jackson Hole headlines and have at least as high medium-term importance.

From this perspective, it is worth noting first of all that the speeches of the main central bankers continued to lack firm and clear “forward guidance” elements. In my view, this shows that there remains a cautious attitude by most central bankers to anchor themselves in firm targets for the future level of reference interest rates. I see this approach as confirmation that central banks remain acutely aware of the high level of unpredictability in the short and medium term, which argues for the current preference for a “see and do” approach depending on what the data will show and the information that will become available in the next period regarding the progress of the economy and prices.

At the same time, many economists point out that the approach to monetary policy in the fight against inflation must be different according to the particularities of each economy. The most important differentiation is between the situation in the US and that of the Eurozone, but the differences are equally great between developed and emerging economies. While in the US the current economic situation and the structure of price dynamics show that the increase in the monetary policy interest rate could act quite effectively to curb the rise in prices in the medium term, in the Eurozone the strong link between inflation and factors beyond the influence of classical monetary policy instruments (such as energy prices) probably implies, at least from a theoretical perspective, a smaller magnitude of the overall increase in the monetary policy interest rate.

An important element from the perspective of emerging economies (as is our case), but which has implications for global financial stability, is that the measures recently taken by central banks in developed economies come after a considerable period of time in which central banks in economies in development have already significantly increased local reference interest rates in numerous stages. This fact is less mentioned by financial analysts, but it is of crucial importance for preventing a global financial crisis. So, while central bankers in developed economies are often accused of being late (as are those in emerging economies), the fact that emerging economies have had time to tighten monetary policy significantly prior to central bank moves from developed economies is a great gain for global stability, especially since the time available to emerging economies was sufficient even for interest rate increases to be gradual, thus easier to absorb locally. A recent reference in this direction was made by the head of the Bank for International Settlements, Augustin Carsten, who stated that central banks must have a realistic approach to the effectiveness of policies to influence short-term demand to fight inflation, in the current economic context.

Another important concern of the last period that has emerged from the discourses of economists in recent days, even if sometimes only between the lines, is that of the need to rethink current economic models that are essentially based on the principle of dynamic balance and that of rational anticipations. Nobel laureate economist Joseph Stiglitz noticed last week that these models are less likely to be helpful in calibrating economic policies now and in the near future, since we are in a situation of obvious imbalances that are likely to continue at least in the medium term, and further supply-side shocks are very likely in the years to come, as long as geopolitical tensions continue to be present.

As is known, the state of equilibrium is a theoretical concept. There are always dynamic forces that prevent an economy from reaching and sustaining this balanced position, and realistically, we are always in a state of disequilibrium that tends toward a theoretical equilibrium. However, there may be certain situations where the imbalance becomes more pronounced. Commonly used and established economic theory suggests that all markets work toward market equilibrium, where supply and demand reach a balance and there is no overproduction or underproduction. It is clear that such balances are difficult to achieve in an economic environment that will remain dominated by uncertainty and high risks for the foreseeable future and will likely continue to be affected by further external shocks. That is why it would be useful to investigate some models based on the permanent adaptation of economic agents to new changing realities against the background of a prolonged state of disequilibrium, in the conditions where their expectations and forecasts lack accuracy due to the incomplete information available. Joseph Stiglitz also notes that in such a conceptual framework, policies aimed at increasing the flexibility of the economy and its ability to quickly adapt to new conditions are of particular importance, especially with regard to the supply of production resources and supply in general. In this context, the flexibility of the labor market is also of great importance, as well as the mechanisms of automatic stabilizers that are already enshrined in the theory and practice of public policies.

The above principles are broadly supported by recent statements by another Nobel laureate in Economics, Lars Peter Hansen, who advocates a greater role for fiscal policy in stabilizing the economy and fighting inflation, as well as for rethinking economic forecasting models used in policy decisions. In a paper co-published with Michael Barnett and William Brock, they argue in favor of connecting economic and climate models, given the obvious two-way link between economic and environmental sustainability, and the influences of both on social well-being.

The brief enumeration above presents only a few of the fundamental concerns of economists at the present time, but with profound local implications for all world economies. Some of them are not new at all, for example reiterating the important role of fiscal policy in complementarity with monetary policy and structural reforms to combat the negative effects of the overlapping crises we are currently facing, but also to transform the economy by adapting to the new realities. The need to rethink the analysis and forecasting models used to calibrate the mentioned policies is not new either, but it is increasingly important in the context of imbalances and exogenous shocks anticipated to persist for a significant period in the future. Digital transformation, climate challenges, combating inequalities and promoting social equity have been on the agenda of decision-makers for a very long time, but the sharpening of these major externalities of the current crises turns them into an increasingly acute priority. All these fundamental concerns remain dominant and will continue to form the background of any discussions on specific policy decisions.