Context

Economic-policy discussions increasingly revolve around the question of when and how quickly central banks should pull back the uber-stimulus measures implemented last year in response to the pandemic.

Why withdrawal is challenging?

• Uncertainties: Both parts of the question (when and how) call for finely balanced judgment to account for uncertainties that are in play.
• Policy changes by major central banks can have far-reaching implications for economic and financial well-being, affecting not just those directly involved but also the many nations.
• To answer the question, an assessment of three current issues is required:
• The labor market.
• The surge in inflation.
• The risk of not being able to recover quickly in the event of a policy mistake.

Let’s look into these three issues

1) Labour market puzzle

• Despite massive demand, the labor market is unable to match unemployed workers to jobs.
• The situation is particularly stark in the US.
• Job data for April show that there are a record number of job openings in the US—more than nine million—labor-force participation remains stubbornly low, and unemployment high, compared to pre-pandemic levels.
• The labor market’s persistent malfunctioning—particularly employers’ struggle to find employees—is likely to lead to higher wage growth, a possibility that fuels concern about the second issue-inflation.

2) Inflation: Is it transitory or long-lasting?

• There is a view that the current uptick in inflation will sharply reverse itself.
• As the year progresses, it is expected that the base effect will wash out together with the supply and demand mismatches.
• However, there is a possibility of supply bottlenecks, changes in supply chains, and lasting inventory management challenges.

3) Policy challenges: To act or not to act

• Policymakers must be mindful of the risks associated with any given course of action—including inaction.
• In the face of such uncertainty, it is wise to ask not just what could go wrong but also what the consequences of a policy mistake would be.
• Under the current conditions, a wrong move could have far-reaching, lasting effects.
• Those favoring a continuation of loose monetary policies argue that central bankers still have tools to overcome inflation should it persist.
• But as the opponents are quick to point out, those tools have become increasingly ineffective and difficult to calibrate.
• The risk of inaction (or inertia) in this case may be larger than that of acting early.

Options with systemically important central banks

• In the case of the US, economic growth is buoyant, fiscal policy is also extremely expansionary, and businesses and households alike have significant accumulated savings that they will now be spending down.
• The conditions are now ripe for the Fed to start reducing—gradually and carefully—its bond-buying program from its current rate of $120 billion per month.
• The European Central Bank, however, is in a different position.
• While eurozone growth is picking up, the level of financial support is not as strong as in the US, and the private-sector recovery is not as advanced.
• The hardest case to call in the UK.
• With growth, fiscal support, and the private sector’s prospects more finely balanced.
• Other central bankers around the world also have an important role to play.
• Central bankers elsewhere should be running their own scenario analyses and formulating appropriate response plans.

Conclusion

There is nothing wrong with hoping that three systemically important central banks will get to their destination smoothly. But the journey is far from over, and the risk of someone slipping is not negligible.

Back2Basics: Labour force participation rate

• The labor force participation rate is a measure of an economy’s active workforce.
• The formula for the number is the sum of all workers who are employed or actively seeking employment divided by the total noninstitutionalized, civilian working-age population.
• Used in conjunction with the unemployment numbers, it offers some perspective into the state of the economy.

Source:

https://www.financialexpress.com/opinion/withdrawal-symptoms-central-banking-fast-and-slow/2295940/

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