Inflation, ideology, debt and war: unsettling snapshot from OMFIF advisory council

‘We haven’t yet found out who is swimming naked when the tide recedes’

Inflation is likely to remain much more entrenched in the main industrial countries than central bankers wish, while the Russian-Ukrainian war is driving a wedge between the US and much of the rest of the world. These were two conclusions from a meeting of the OMFIF advisory council on 18 April, providing an unsettling snapshot from five continents of the tense political and economic environment around the world.

China is growing more quickly than expected after ending its Covid-19 lockdown, amid optimistic signs of successful restructuring of the troubled real estate sector. But the likelihood of further international increases in interest rates to quell stubborn inflation is intensifying difficulties for indebted countries in both the developed and developing world. One senior ex-central banker said it was a ‘pipe dream’ to think inflation would quickly fall to the generally targeted 2%. Another council member said, ‘A return to central banking orthodoxy will not be easy at all.’

A former finance minister noted how central banking independence was much more difficult to uphold in an age of quantitative easing (and now gradual tightening). Interactions between treasuries, debt management offices and central banks now holding very large quantities of government debt necessarily impeded the authorities’ ability to act independently of each other.

International development institutions led by the World Bank will need to devote greater resources to help combat international debt problems – even though fiscally pressed governments are reluctant to provide more capital to these bodies. Reflecting on changes in the World Bank leadership, one participant wondered whether the institution should shift more attention to debt relief alongside emphasis on environmental, social and governance-orientated investments.

Russia and China seen as coordinating to split the world into factions

Much attention was devoted to the parlous state of politics and society in the US. America’s lead on the Ukrainian conflict is often met with suspicion or hostility in large parts of the ‘global south’. Russia and China were seen as coordinating to split the world into ideological factions. One senior American commented: ‘Regardless of the strength of the US economy and the dollar, the country is in a total crisis [reflecting issues such as] gun control, abortion and whether [former President Donald] Trump will go to jail.’

A general spirit of introspection was abroad. ‘America is not on its way out. By its very existence America is at centre stage… The US is key to many of the issues preoccupying the world, but if the world asks America, America is often not listening.’

According to the analysis of one African member. ‘In Africa, the US lost a lot of ground to China.’ China tends to deal with ‘transactional issues that African countries are interested in.’ America was ‘declining from within: the entry of Donald Trump into US politics is a phenomenon not yet fully understood’.

Uncomfortably for the West, African countries were looking at the Ukrainian conflict with the US as an imperialist power, while Russia was viewed as protecting its strategic interests. ‘The US is trying to claw back some ground that it has lost in Africa, but the jury is still out on whether this will succeed,’ he said.

His views were echoed by a Latin American delegate. He endorsed a remark ascribed to Larry Summers, a former US Treasury secretary. ‘The Chinese are coming and building an airport. The US comes to give us a lecture and tell us what we should be doing.’

Despite solidarity on Russian sanctions, Europe and the US remain somewhat tenuous allies. Europe attracted displays of both concern and relative indifference in view of slow growth and contradictory policies on America.

French President Emmanuel Macron was criticised over recently intensified comments emphasising Europe’s quest for ‘sovereignty’ and ‘autonomy’, particularly in the light of Sino-American tensions over Taiwan. It was pointed out that, as a result of the Ukraine war, Europe’s industrial, military and energy dependence on America was growing, while Taiwan has an important strategic role in view of its central position in chip manufacturing.

Long-term inflationary factors complicating life for central bankers

On the economic and monetary front, a well-known international economist underlined many long-term inflationary factors complicating the life of central bankers. On top of pre-pandemic structural deficiencies come 20 years of ultra-loose monetary policy, post-pandemic ‘hysteresis’, population ageing, costs of mitigating and adapting to climate change, rises in commodity prices caused by depletion of old mines plus the outcome of deglobalisation. ‘How do central banks respond to persistent negative supply shocks?’ he asked. All this has large-scale political implications with the ‘hollowing out’ of the middle classes in modern industrial countries and the rise of political extremism. ‘There is a long run of questions where we don’t have answers.’

One speaker said central bankers’ self-congratulation over meeting inflation targets in the past two decades was misplaced. Central banks were increasingly relying on words for policy actions, but the impact was unclear. In the UK, inflation could fall to 4%-5% reflecting ‘base effects’ but would prove ‘stickier’ to move lower.

Persistently higher interest rates after a period of excessive monetary easing were seen as disrupting business models in companies around the world. As one speaker noted: ‘The implications of living in a high interest rate world are only slowly sinking in… We haven’t yet found out who is swimming naked when the tide recedes.’ Others pointed out that interest rates in real terms were still negative in many jurisdictions. This casts doubt on how successful central banks would be in the anti-inflation fight.

On financial stability, recent bank upheavals centred on Silicon Valley Bank and Credit Suisse have shown the obsolescence of widespread notions of liquidity and solvency, according to a leading US participant. ‘We are in an era of a new character of bank runs, exacerbated by social media and automation of deposit withdrawals.’

There was a debate about whether central bank digital currencies would provide a new route for ’narrow money’. If that happened, central banks would be taking back full seigniorage from commercial banks, restoring the position of 300 years ago, with big implications for banks as well as for government financing. There appears to be consensus that CBDCs are possible and have desirable features but final decisions will be taken by politicians.

David Marsh is Chairman and Taylor Pearce is Senior Economist at OMFIF.

The meeting of the advisory council – with speakers from Brazil, Nigeria, Canada, China, India, Malaysia, Singapore, the UK and the US – took place virtually on 18 April, chaired by Philip Middleton in the absence of Meghnad Desai.

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