In November 2021, the Federal Reserve Bank of New York, the European Commission and CEPR brought together US- and Europe-based policymakers and economists from academia, think tanks and international financial institutions to discuss issues facing transatlantic policymakers. This column summarizes key themes and outcomes of conference discussions such as how to support growth while addressing inflationary pressures, facilitating climate change and reducing economic inequality; What changes in the new monetary policy framework of the Federal Reserve and the ECB; and how to combine optimal public finance.
The Federal Reserve Bank of New York, the European Commission and CEPR jointly organized a conference on “Transatlantic Economic Policy Responses to the Pandemic and the Road to Recovery” on 18 November 2021. The conference brings together US- and European-based policymakers. and economists from academia, think tanks and international financial institutions to discuss issues facing transatlantic policymakers. The conference was held ahead of Russia’s aggression in Ukraine and global financial tightening. Nevertheless, its medium- to long-term focus provides interesting insights into the economic policy challenges ahead.
Several questions were addressed by the panelists: What can be done to support growth while addressing inflationary pressures, mitigating climate change and reducing economic inequality? What are the key changes in the Federal Reserve and ECB’s new monetary policy framework? At what pace will the US and EU integrate their public finances and what role should automatic stabilizers and fiscal rules play in the future? In this column, we summarize the main themes and findings of the conference discussions.
Panels 1 and 2: “Post-Pandemic Policy Challenges in the Medium and Long-Term”, and “Debt Sustainability and Post-Pandemic International Financial Spillovers”
In terms of medium and long-term policy challenges, the panelists considered both the pre-pandemic world (eg, high debt levels, rising inequality, climate change) and new ones (eg, future pandemics, health care systems). .
The panelists noted that the COVID-19 pandemic has had some unexpected effects on inequality. This did not have a major impact on income inequality, as workers – especially those with low incomes – benefited from government support measures. On the other hand, a low interest rate environment leads to very strong increases in asset prices, significantly increasing wealth inequality.
In terms of public finances, debt levels in advanced economies have risen to record highs in some cases. But interest rates were low and expected to remain relatively low for some time, moderating short-term concerns about debt sustainability and reducing the risk of austerity measures being imposed. Nevertheless, high public debt has significantly reduced fiscal space in many countries.
To deal with both inequality and debt levels, the panelists considered that taxes should be raised. Recently there have been some positive developments on the taxation front, for example the International Corporate Taxation Agreement (although this should not be considered the end point of a process, but rather the beginning of something that could be much bigger). However, more was needed: more efforts should be made to close tax evasions, fight tax evasion and reduce tax evasion. Moreover, one panelist emphasized that the rich should be taxed more, although whether this would be politically feasible, especially in the United States, remains to be seen.
On climate change, the panelists noted that the world does not yet have the technology to fully address it. In any case, technology alone will not solve the problem. The challenges of global warming were not just about ingenuity and technology, as they required significant changes in the behavior of society, making them macroeconomic and political problems as well. The costs of climate change will be macroeconomically significant. Therefore, income support was needed to mitigate the impact of change on low-income groups. A carbon tax can enable policymakers to effectively spend money on green transitions.
As for health challenges, the panelists observed that the management of COVID-19 at the global level was not a good example of multilateral cooperation, especially vaccine distribution in developing countries. Looking ahead, it was important for the European Union and the United States to find ways to cooperate with other countries, including China, to address pandemic-related challenges, as they cannot be resolved without international cooperation.
The panelists also argued that governments will need to spend heavily in the coming decades to modernize infrastructure, strengthen healthcare systems and reduce inequality. Thanks to the decisive response to the pandemic, governments and institutions have regained some of the credibility lost after the global financial crisis and now have more political capital to face these challenges. According to one panelist, pandemics and climate change have the potential to change the way the challenges ahead are perceived as ‘existential battles’. And ‘wartime’ extraordinary measures may be acceptable to citizens if the war is to be won.
Fireside Chat: New Federal Reserve and ECB Strategies – Implications for Monetary Policy
In a virtual ‘fireside chat’, New York Fed President John Williams and ECB Chief Economist Philip Lane focused on new frameworks for monetary policy recently made at their respective institutions. In her role as moderator, CEPR President Beatrice Weder de Mauro asked the speakers why they think new strategic approaches to monetary policymaking are warranted, what the similarities and differences are between the Fed and ECB frameworks, and what economic assumptions underlie these developments. was valid.
In his reply, Lane acknowledged the existence of differences in fiscal structures in the two cases, but – he argued – they did not reflect differences in the preferences of policymakers. Rather, they were prompted by deep-rooted asymmetries in macroeconomic conditions between the United States and the euro area. As an example, Lane cites large chronic current account surpluses in Europe versus deficits in the United States, which have implications for inflationary pressures. According to Lane, the euro area experienced more downward pressure on inflation than the US in the pre-pandemic period. To address these issues head-on, the new ECB framework insists that inflation must stay at 2% over the forecast horizon, not just in the near term. He noted, however, that the pandemic experience has ushered in new challenges related to supply-side constraints and cost-push shocks that have altered the dynamics of inflation.
Williams noted that a specific asymmetry between the Fed and ECB frameworks was related to the dual mandate of price stability and maximum employment for the US central bank, hence the need for the US framework to address both goals equally. Depending on the specific nature of the demand versus supply shocks hitting the macroeconomics, these goals may be in conflict in the short term, and the stability and size of the shocks require appropriate policies to restore the desired outcomes. Prior to the pandemic, slow-moving demographic and structural factors contributed to a low natural interest rate environment, which limited the effectiveness of monetary policy as a tool to guarantee maximum employment, and contributed to low levels of inflation, which have potentially adverse effects. Stability of Inflation Expectations. Williams said an evolution of the US strategy was warranted, and in the new framework that was marked in terms of achieving an average inflation level of 2% while focusing on employment deficits from the maximum level.
Vedder de Mauro asked both speakers to assess how the new monetary policy framework, which emerged during a period of undershooting inflation, was able to address the specific challenges of the current high inflation that has resulted in significant overshooting of the central bank’s objectives. In particular, he asked what their confidence was that the markets were understanding the new strategies. The key question was how quickly cost-push shocks and Covid-related imbalances in the energy sector would resolve over time. Williams emphasized that the factors underlying the low r* environment probably did not change during the pandemic, so the new policy framework was relevant. The new framework was well suited to cope not only with periods of low inflation and demand imbalances but also with price increases reflecting supply and cost-push shocks.
Keynote speech by Commissioner Paolo Gentiloni: “From recovery to rebuild: three priorities for the post-pandemic economy”
In his keynote, Commissioner Gentiloni, after reviewing the unprecedented policy responses on both sides of the Atlantic to support the economy, outlined three key policy priorities for the post-pandemic economy: (i) delivering what was agreed; (ii) avoid past mistakes; and (iii) write a new story together.
On delivering what was agreed, Commissioner Gentiloni stressed the importance for the EU to make the Next Generation EU a success, in particular by making effective use of the funds disbursed by its key instruments, the Recovery and Resilience Facility, and ensuring that Member States maintain Their commitment to economic reforms. To this end, the United States should implement bilateral agreements on infrastructure that will modernize its transportation and communications systems as well as help address the challenges of climate change. Commissioner Gentiloni stressed the importance, both in the EU and the US, of enacting legislation without delay that would enable international agreements on taxation, representing a ‘victory for multilateralism’.
On avoiding the mistakes of the past, Commissioner Gentiloni noted that governments should not move too abruptly from supportive policy positions to restrictive ones. Public investment should not harm fiscal consolidation, while public debt reduction should not come at the expense of investments needed for recovery or green and digital transformation.
Finally, on writing a new story together, Commissioner Gentiloni argued that, since the EU and the US share the same vision of recovery aimed at reducing inequality and tackling the climate crisis, they should work together to establish a ‘new era’. of strong and sustainable growth’. The term ‘sustainable’ in this context covers three dimensions: (1) ensuring debt sustainability in the medium term while promoting a more growth-friendly structure of public finances; (2) implementing ambitious climate change commitments by translating them into concrete actions; and (3) strengthen associated social models to fit them for the future.