There is an odd sense of indecision in the air as the world’s central bankers and finance ministers meet in Washington at the annual meetings of the IMF and the World Bank this week after a gap of three years. The multiple disruptive events that have intervened – the pandemic, the war in Europe, the surge in inflation, the hints of fragility in financial markets – have put these decision-makers on edge.
It seems that there is no new “Washington consensus” on how to deal with current financial policy challenges. Far from it; debate and disagreement prevail. Old certainties are being reassessed and questioned, given the unprecedented events that have affected markets since early 2020.
Now, when it comes to any of the multiple areas of difficulty that exist in the financial world today, there is an unusual degree of doubt... even as to which way policy should turn
In the past at such gatherings, uncertainty was mostly quantitative. The questions about financial policy were ones of degree, not direction: how high should interest rates go, how much public borrowing could be justified. Now, when it comes to any of the multiple areas of difficulty that exist in the financial world today, there is an unusual degree of doubt among participants even as to which way policy should turn.
Take just a few of the most prominent financial policy issues being discussed.
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How best should governments act in order to maintain overall financial stability, minimize the risks of another recession, shorten the duration of high inflation, protect the solvency of low income countries, and reduce the intensity of climate change? Experts disagree. And these policy uncertainties reflect neither some simple right-left political divide, nor even a creditor-debtor divide.
As far as financial stability is concerned, Monday’s announcement from Stockholm that the 2022 Economics Nobel Prize had been won for innovative mathematical models that analysed financial crises might prompt the comforting assumption that reliable tools now exist to foresee and prevent another collapse in this febrile situation. But the opaque investment practices of today’s financial markets introduce complexities that are beyond the scope of those models, as is dramatically evidenced by the market disruption that has followed the misjudged UK budget of a fortnight ago.
Before the budget, the Bank of England increased interest rates to dampen inflation, and was about to start selling the UK government bonds it had bought when inflation was too low. Immediately after the budget though, long-term UK interest rates made an unprecedented jump to levels much higher than envisaged. This triggered an unforeseen cascade of losses for pension funds which had bet on continuation of low rates. Now the Bank of England has been buying bonds again, but insists it will resume its planned sales soon. No wonder there is confusion.
Most other central banks have also been responding to the surge of inflation by increasing interest rates; experts disagree here too, with some complaining that action has been too slow, while others deplore even any increase in interest rates when recession is looming, thanks to the war and to a slowdown in China. The European Central Bank has been one of the slowest to increase rates. One consequence has been the decline in the international value of the euro against the US dollar, for which interest rates are higher. By taking a measured approach to raising interest rates, the ECB may be able to ensure that it will not have overdone the tightening if inflation does slow, as seems likely over the next year or two.
Debt relief
High interest rates, on top of the heavy borrowing that was needed to cover the costs of the pandemic, are also threatening the sustainability of public debt in many low-income countries. There will have to be a lot of debt relief. Yet here, too, there is ambiguity and no clear way forward, in this case reflecting the competing interests of different creditors, both public and private. As we in Ireland know well, unresolved public debt issues can have a devastating impact on wellbeing in the debtor countries. The lack of consensus on how best to resolve over-indebtedness in those countries – despite all of the creditors being represented at this week’s meetings – is discouraging.
No general agreement prevails, with competing solutions attracting eloquent advocates, and different countries making different choices
And then there is the question of energy prices. Should governments intervene to hold the prices down, thereby dampening inflationary wage demands? Or should they provide a cash compensation to lower-income groups and allow the high prices to discourage over-use of fossil fuels? Or would some mix of these two be better? And how should such interventions be paid through the government’s accounts? Would taxing away the windfall profits of clean energy firms risk discouraging private investment in that sector, or would it be accepted as a perfectly reasonable response in wartime to excess profits? Again, no general agreement prevails, with competing solutions attracting eloquent advocates, and different countries making different choices.
Each of these problems interlocks with the others, and with a wider range of issues. The decision-making environment is much more complicated than usual, and the decisions are being taken against the background of a darkening global economic environment.
It’s not that most participants expect a downturn on the scale of the global financial crisis, but investors are jumpy and policymakers apprehensive.
Some countries are better placed than others. Clearly, Ireland will be affected by the extent to which other countries manage these problems well. But, thanks to the still-growing flow of corporation tax revenue from multinational corporations, and despite the scale of income supports during the pandemic, the state of Ireland’s public finances is sufficiently good to allow the Government to provide a degree of insulation for households against the rising energy costs.
It should not be forgotten, though, that longer-term economic resilience also requires public spending on housing, healthcare and sustainable (climate-friendly) infrastructure.
Patrick Honohan was governor of the Central Bank of Ireland from 2009-15.