central banks, inflation, energy, pandemic, monetary policy, problem, federal reserve, prices, terms, shale oil boom, recession, question, fed, shock, political, podcast, demand, consequences, french, investment
Helen Thompson, Paul Diggle, Luke Bartholomew
Hello and welcome to Macro Bytes the economics and politics podcast from abrdn, hosted by me, Paul Diggle and my colleague Luke Bartholomew, and we're both economists in the Research Institute here at abrdn. So we're back with Professor Helen Thompson, author of 'Disorder: Hard Times in the 21st Century'. Last week, we talked about energy markets and how they drive global geopolitics, and today we're going to focus on the second big theme from Helen's book, which is the role of monetary policy. One of the points you make in the book is that the successes of monetary policy in taming inflation through the 80s and 90s is as much to do with low energy prices, the fallout of the 70s shocks and the increase in supply that brought online, the China shock, which essentially exported lowflation to the rest of the world it's as much to do with those drivers as it is to do with independent technocratic central banks having solved inflation. But we're now in a period of very volatile energy market, so reverse globalisation is a shock of sorts. Even last week, at the Sintra conference, Christine Lagarde was declaring the end of the era of low inflation. So I mean, the 'great moderation' died with the financial crisis, but it's the post financial crisis, pre-pandemic new normal, this era of low rates, low inflation, low growth, is that also confined to the history books with the shocks we've seen over the past couple of years?
Helen Thompson 01:43
My guess is yes, that it is. I think that if you look at the 2010s. So once the economic recoveries in western economies really got going. And as we know, they were never spectacular economic recoveries from 2008. Oil prices, you know, relatively quickly went above $100 a barrel, and they stayed there for about three and a bit years - so from 2010, sorry, 2011, through to the middle of 2014 - and then the price came tumbling down. And that was both a product of shale supply, the shale boom, shale oil boom really taking off and then the way in which the Saudis reacted to the problems that the American shale oil boom caused them. So there's a period really from, certainly from the latter part of 2014 through to early 2016 where oil prices are very low, very low. And then, when the Saudis realised they can't bankrupt the US shale sector, and they have to basically make a move towards Putin that creates OPEC plus, and they put a floor under prices that lasts until that Saudi/Russian relationship breaks down in the first month or so of the pandemic. And paradoxically, in some sense, it was Trump that put it back together again. I think what's striking, is that, even though in that latter part of the 2010s before the pandemic, so particularly 2019, oil prices crept back up not to levels that were intolerable for western economies but there was a significant slowdown in 2019 in the world economy, and there was a significant issue with the supply of oil, or at least a partially significant issue in relation to the supply of oil in relation to the demand for oil in 2019. Now, the question, then, I think for now would be not only is there anything like the big expansion that shale oil did in the 2010s in the US that can come again? Well, if you look at the data, it's only really the Permian Basin that looks like it's still got lots of growth in it of the existing fields, some of them are clearly in decline, that doesn't mean that a shale oil boom couldn't happen somewhere else. But if you said, okay, where's the most promising place just geologically, where it might happen it's probably Russia. And Russia, as we know, then has got a capital and technology problem because of the sanctions. So there's nothing I think that's obvious that can do what the American shale oil boom did in the second half of the 2010s. At the same time though as we know from the past and pre-shale you have high oil prices for long enough and you will destroy demand. Actually, the other thing I should have put in, though, in terms of the prospects for inflation would be gas prices, which aren't so consequential in terms of like what happened previously, but now I think, are more so. And the fact that actually, there's been a shock, or there's about to be a shock from Germany, in terms of demand for liquid natural gas is a structural factor that is going to keep the liquid natural gas prices high, unless something radically changes.
Luke Bartholomew 05:57
So you talk about, I guess, one of the conceits of the central banking area, that central banks are able to control inflation largely, regardless of where energy prices are going, as you say, energy plays a much bigger part of the story. But another big conceit of the central banking infrastructure is this idea that there's lots of independent central banks who are all setting monetary policy for their own domestic economy, right? Whereas what we really have is a system of core and periphery where the Fed sits as hegemon and effectively sets monetary policy for a large part of the world. Yet, it's democratically accountable to only one part of the world, and you, Adam Tooze, and others have talked about, you know, in moments of crisis, the sort of political, economic consequence of this, the Fed swap lines needing to be rolled out and the profound political choices that are involved in doing that. But it sort of strikes me that that's just crisis era stuff we're talking about there. But just on an ongoing day-to-day basis, it's the Fed that gets to set monetary policy for the world, crisis or not, and the Fed is only accountable to the US government at all times. And this seems particularly pressing right now in the context of this interest rate hiking cycle. So I'm wondering sort of what democratic and economic vulnerabilities do you think lie in what seems to me this sort of deep contradiction in the, in the sort of democratic accountability of the way central banking is set up?
Helen Thompson 07:30
Yeah, well, obviously, if you go back to the 1920s and particularly actually, Britain's predicament in the 1920s, this problem is, is pretty crucial to what happens, including in the end, I would say Britain's exit from the gold standard in 1931. So you have British politicians who think of themselves as accountable to British voters and want to win elections, and they would like interest rates to be significantly lower, but really, the Bank of England has to follow what the Federal Reserve was doing. And if you read some of the memoirs that Winston Churchill wrote when he was Chancellor, then they're full of this really dark night of the soul stuff about this problem of the relationship between democratic politics and the subordination of Britain monetarily to the to the Federal Reserve. And I think if you, if you skip on to the 1980s, you can see a lot of the frustration in France, during President Mitterrand's presidency that actually provides the context provided the context for the French push for monetary union within the European Community, as it then was coming out of much the same problem except for the fact that the French, by that point had got two central banks that were containing what they could do not just the Federal Reserve in the first half of the 80s, but the Bundesbank in the second half of the 1980s. And I think that we're going to see as the problem of how do individual central banks, not the Federal Reserve, deal with the inflation problem. It is going to get pretty difficult if the Federal Reserve wants to do something that is quite an outlier from what others would do. Now, having said that, I mean, the outlier, I think at the moment just in terms the major central banks, in terms of what they want to do is, is the Bank of Japan, in being so opposed to any tightening at all, being so reluctant to engage in any tightening at all. I would say, though, as well, that it isn't really just a question of the democratic problem. It's a problem for China, as well. And you could see that already in the middle of 2010s in the 2015/16 Chinese financial crisis, which was a big, big blow for the Chinese leadership. If you look at what the run up to that was, it was the knowledge that by the end of 2015, that Janet Yellen's Federal Reserve, the Federal Reserve was going to just increase interest rates by .25%, and it causes carnage for China in terms of capital flows and the Chinese share markets. So I think it's not only for Western democracies, what do you do when your central bank is following the world's leading central bank? It's also a sovereignty question or it can be perceived as, it will be perceived as a sovereignty question. And then, you know, the kind of financial crisis that China had in 2015/16 had all kinds of like, knock on consequences. And if you wanted to go back a bit further than that a country that's obviously was significantly more vulnerable than China, where the consequences were geopolitical was Ukraine, you know, and the problems that Ukraine financially had and its currency had after Bernanke had said that the Fed was going to start tapering purchases. And it was because Ukraine didn't get any meaningful financial support in dealing with that crisis from either the US or from the European Central the ECB or the the Federal Reserve that Yanukovych turned to Putin and set in motion, the set of events that led to his removal from power, and the Crimea, the annexation of Crimea. So there's pretty big geopolitical stakes for some countries, too, in terms of the consequences of what the Fed decides to do.
Luke Bartholomew 12:37
And then just in terms of the way democratic governments interact with their own domestic, central banks, I guess, putting the sort of questions of inflation control and demand management, economic management in the hands of technocrats that seem to work, or be politically possible in a world of low inflation, steadyish growth. Now, the inflation is much higher, and we all know inflation is a deeply political question. Does that kind of sense of independence of central banks and democratic governments sort of washing their hands of it almost and saying, you know, not our problem, it's up to these guys to fix it. Is that sustainable? Are there questions about how long independent central banks can continue to exist in that sort of environment?
Helen Thompson 13:27
I think that's a really interesting question, because I think it's very difficult to know what the answer is. And that's what makes it that's what makes it interesting. I think if you go back to the the 2016 US election, and think about Trump and Bernie Sanders as insurgent candidates for their party's nominations, albeit very different kinds of ultimately insurgent candidates, there were a number of issues in which they really made common cause. And one of them was attacking the Fed, in these kind of terms sort of saying, look, it presents itself as technocratic. That's not the words that Trump used but, but really, it's making political decisions all the time. And there are people who are winning from this in finance, and there are people who are losing from this. If you look at the left, more generally the radical left, there's obviously been quite a lot of interest since 2008 in modern monetary theory, and this idea that actually you can do the technocratic thing if quantitative easing is a sort of technocratic thing, but you use it for a different purpose. I mean, I think there's quite a bit of thinking on that that's quite muddled. But if you just treat it as a political phenomenon. What I see less of is any clear evidence that anyone is really saying any significant political constituency is really saying actually politicians need to be back in charge of central banks, even in the Eurozone, I would say where you could see it in things that French prime ministers and French finance ministers would say, in the 2000s, leading up to 2008. You could actually see it in some of the things that Berlusconi said as well, in actually 2008, the Spanish finance minister and was saying that these are political decisions, they've got to have some political influence over them. I don't really see that. I think that was a kind of a constant theme in French policy, really going back to the latter years of Bretton Woods, certainly by the point in which the Deutsche Mark was the strongest currency in Europe - this idea of there being political control over monetary policy is a pretty persistent French demand. And actually, they hoped, the French ministers, who were pushing monetary union hoped that that would be the end result of it, obviously, it was never going to be because the Germans weren't going to give up the Deutsche Mark on those terms. But I don't really see that coming out of France now, and maybe I'm missing it, but I think you see much more the idea, the critique of the euro, if there is one still, of being, that it needs to be debt sharing, and/or that it needs to be more of an alternative to the dollar rather than it being so that there needs to be a geopolitical currency rather than having a politicised monetary policy. Now that may be because the European Central Bank has been quite wary so far, about the way that it's dealt with inflationary pressure. And if there's a sharp turn towards monetary tightening, we might, it's possible I guess, that that French narrative will return. But I think in France, at least, I think something has changed. Or at least it's possible that it's changed.
I mean the macro management change that seems to be underway, at least pre- pandemic was a tentative, resurgent fiscal activism, or at least a consensus building among economists that in an era of low rates, debt overhang seemed to matter less and there was more scope for fiscal policy. Macro management didn't need to be completely be handed over to monetary policymakers. And it strikes me that actually the change that will come after this experience isn't a threat to the independence of central banks, but rather a threat to that emerging fiscal activism, because it'll seem like it was the Biden stimulus what did it in terms of the breakout of inflation? I mean, is that the way that the monetary fiscal architecture changes, actually, rightly or wrongly, high inflation will be pinned on too much fiscal policy, and then we get much less use of that in the future?
Helen Thompson 18:07
I think that that we can already see that there's a contest going on and narrative contest going on about who to blame for this inflation. And I think if you just take the United States, you got a narrative that comes out of the right, that's about fiscal stimulus, Biden sending a check, not just actually Biden, because obviously began during Trump, essentially, the pandemic stimulus is to blame. And then from the administration itself, it's Putin's to blame. It's about energy - but it's not about energy - because of energy's own dynamics - it's because Putin war is to blame. It seems to me that neither of those narratives are very convincing. Aside from anything else, because it is about energy, but the energy inflation was already there and being talked about last second half of last year, and indeed, Biden was already showing he was very worried about it, because he was asking OPEC Plus, to do something about getting oil prices back down. Again, pretty publicly from last August, as I recall. I think if we turned to Europe, the fiscal stimulus argument doesn't really work. I mean, even in I mean, I'm not particularly convinced by it in the US case, but at least you could say it's sort of a marginal fact. It's not the underlying issue, but it happened. Whereas I think it's pretty difficult for anybody to turn around and say, okay, it was the EU's recovery fund and debt sharing that's to blame for this. I mean, that would seem to be an absurd argument, I think, to even try to make, and I don't hear anybody trying to make that in a Eurozone country. So then the question is, well, what kind of narrative about energy is going to stick? And how can it stick when we're talking about monetary policy itself? When, as we know, really the only tool that central bankers have for dealing with energy inflation is to steer the economy towards slower growth, if not recession - essentially to act as an agent of demand destruction in order to get energy prices back down again. Obviously there is a potential secondary question about whether wage inflation then becomes a problem in response to energy like crisis. Maybe we are beginning to see in Britain, like unions pushing for higher wages in response to rising energy and food prices. But I still think that, on that point, this is where what central banks did last time did have consequences because it definitely depressed the political power of organised labour and their ability to demand compensatory wage increases in response to energy inflation. Now, you might argue, one could argue that there's something about the pandemic that is strengthening the bargaining power of labour, not because anything changed about the long politics of that just because of the shortages of labour in certain sectors of the economy and the difficulty in hiring people to do jobs. But I still think that the core of the inflation problem that central banks will be grappling with, will be the energy and food core to it.
On the topic of central bank demand destruction then, the question on everyone's lips is how does this rate hiking cycle end, and in the book, you talk about several central banks hiking cycles into high energy price inflation, which in the end ended up in a recession - the Fed in 2008 not stimulating enough, the Eurozone in 2007 and 2011, sorry, Trichet hiking into energy price strength, but also a burgeoning Eurozone crisis and recession at the time. And today, of course, we're experiencing very front-loaded rate hikes during an energy price shock, even as the global data flow is weakening, and some nowcasts already have us in contraction. So with the caveat, that you're a political economy historian, not a jobbing economist, does this end in recession?
Helen Thompson 23:15
I think so. I think so. Yes. I mean, I think the data is already heading in that direction. I think if you look, historically, at energy shocks of the magnitude that this one is, and I put it starting at last year, rather than starting with the war, then they've all had a recession, those kinds of energy shocks, have all had a recession that's followed them. You could put in a caveat and say, well, it's different this time, because what had come before had got a pandemic and shut down significant parts of the world economy before it, I think that, and that kind of means that the pattern isn't quite the same. Nonetheless, I think that energy is so pervasive and systemic in its consequences, particularly the relationship between energy prices and food prices, that it's quite hard to see how a recession is avoided.
Professor Helen Thompson, that was a fascinating discussion. Thank you so much for joining us on Macro Bytes. A reminder that Helen's book is 'Disorder: Hard Times in the 21st Century'. It dives into all the issues we've discussed today and indeed many more. We thoroughly recommend it. And if you are enjoying Macro Bytes from abrdn, please give the podcast a like or subscribe on your podcast platform. But otherwise, goodbye and good luck out there.
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