Central bankers rewrite monetary policy rules at Jackson Hole

Attention turns to Federal Reserve chairman Jerome Powell as he gives the keynote speech at the central banking shindig on Thursday

Suited men at Jackson Hole
Usually hosted in a ski resort in Wyoming, this year's Jackson Hole event will be held virtually

It is not easy being masters of the universe. After central bankers took centre stage in the financial crisis, the world has grown used to relying on the officials to help out whenever the economy or markets have hit a rut.

Cut interest rates here, print $700bn there: they have kept markets together, dished out breaks to borrowers and sought to power the economy, or at least stop it falling off the rails.

But now they are in a tight spot.

Interest rates had barely risen since the credit crunch, before the pandemic forced them back to rock bottom.

Even in the US, which led the way to "normalisation" among major economies, interest only reached a rate of 2.5pc at the end of 2018 and had to cut back again last year.

Now rates in the biggest economy are back down as low as they can go, or at least as low as the Federal Reserve has ever taken them: keeping the Federal Funds Rate within a target range of between zero and 0.25pc.

It means officials face this extremely deep recession and a recovery of unknowable speed with very little remaining ammunition. Back in the financial crisis, the Fed cut rates from more than 5pc to almost zero. Now it is much more constrained.

In turn, that means finding new ways to stimulate activity, by keeping borrowing costs down and reassuring businesses and families that the central bank is here to help.

Jerome Powell, chairman of the Fed, is giving the main speech at the Jackson Hole symposium, an annual get together of central bankers.

Usually held in a ski resort in Wyoming, this year it is a virtual event. Nevertheless, financial markets, economists and officials will still be hanging on to his every word.

The key hope among observers is that Powell will give a strong indication of the results of the Fed’s long-running review of its policy tools and options.

Top on the list of things to look for is a hint that the Federal Open Market Committee (FOMC) will no longer stick to its usual goal of getting inflation back up to target but instead could let it overshoot for some time, in a policy known as average inflation targeting (AIT).

“We expect the FOMC to say that they plan to hit 2pc inflation ‘on average, over time’ and  to go on to note that overshooting 2pc inflation is not only acceptable, but desirable when inflation has undershot 2pc persistently and inflation expectations have been pulled  down,” says Seth Carpenter at UBS.

Effectively that means committing to “keeping the funds rate at zero for as long as is necessary to ensure full employment and an overshoot of inflation".

In the past central banks have attempted to achieve this with "forward guidance", trying to steer markets’ expectations and pass lower interest rates on to families and businesses.

However, the approach has not always been successful. In the UK, for instance, one of Mark Carney’s early moves in 2013 was to say the Bank of England would not start considering raising interest rates until unemployment fell below 7pc.

It was intended to be reassuring, as the Bank thought that condition was several years away.

Instead, unemployment plunged rapidly and so the target was hit in six months, when the Bank was still years from raising rates.

This time the focus is likely to be simply on promising to keep rates low, almost whatever happens.

“The key impact of AIT is not that the Fed is even able to create inflation, just that it is pre-announcing that it will be lax in responding to a rise in inflation,” says John Hardy at Saxo Bank.

In part, this is because of the extreme uncertainty around the shape of the recovery, which makes it hard to know which other metrics to choose as the basis for forward guidance.

It means some of the speech is likely simply to include basic reassurances.

“We expect Powell will hint towards implicit average inflation targeting and will state that the Fed is ‘not thinking about thinking about raising rates’,” says Lydia Boussour at Oxford Economics.

Other options exist, even if economists think them less likely.

The Fed could try to hold down longer-term interest rates in the market, for instance, by shifting its purchases under quantitative easing to bonds with longer maturities.

Negative interest rates could be an alternative. Powell has ruled them out several times, so there appears little chance they will make an appearance this week.

The Bank of England has rejected the policy in the past, yet is now considering the possibility of going sub-zero.

Expect interest rates to be pinned to the floor for as long as any of us can forecast.

If that is not enough, look out for signs that the ball is being passed to governments to work out how to boost growth for the future, despite their huge new debts.