Central Banking Funambulism and Real-time Data
Nearly every central banker in the world is currently embarking on a tightrope journey, with the endgame being the successful containment and lowering of inflation back to policy target settings.
Falling off the tightrope can be dangerous for both the funambulist and the central banker; injury and loss of life for the former and causing severe damage to the economic fabric in the form of hyperinflation, currency depreciation and long-term societal impairment to the latter.
Some central bankers have begun the journey with confident strides while others, such as the ECB, remain nervously tentative. It is now all about timing, pace, and careful balance. To contain this global inflation pandemic, the central bankers of major economies are looking for a more coordinated response. However, this is not straightforward. To ensure the tightrope has the correct tension, each central banker needs to be able to fine-tune their monetary actions to their respective country’s inflation idiosyncrasies.
Central bankers have different widths of a tightrope to balance on but universally have similar balance bars. These bars, however, appear to be weighted differently in terms of economic growth on one side and monetary policy medicine (interest rates) on the other. This is challenging for our funambulist who has control over interest rates but not necessarily over economic growth. Increased government spending would stimulate growth but boost inflation. How would you feel if you were on a tightrope between two skyscrapers and the gradient of your rope would suddenly increase?
The width of the tightrope is determined by the leverage of household and government debt to GDP. Household debt crudely measures the public ability to absorb painful monetary policy medicine, while government debt represents the fiscal capacity of the government to provide an occasional lending hand to prevent our funambulist from falling (hay in the haybarn). The wider the tightrope, the easier it is to keep balance and the quicker the pace of the crossing.
Timing is everything and requires real time data to be able to keep balance, withstanding unpredictable movements caused by applying different doses of monetary policy (raising of interest rates). On a tightrope, the walker needs to instantly assess the movements of the left hand against the impact to the right.
Access to real time data and an ability to analyse it must be a central plank (pun intended) to every funambulist. It is interesting to observe that some countries have reasonable monthly data around economic growth and inflation, whilst others like New Zealand and Australia are still in the dark ages with a lag of 3 months (1/4ly) actual data.
If the blunt tool of monetary policy (the raising and lowering of interest rates) determines the pace of the tightrope walker, surely the walker requires real time data to immediately understand what impact higher/lower interest rates have on the economy and on their end game inflation objectives.
GDP Live and Inflation Tracker appear obvious prerequisite tools for central banker tightrope walkers. Real time data analysis might not be the forecaster’s holy grail but without it, central bankers might as well continue to have a conversation with an astronaut in deep space waiting 3 months for every response!
Global economies have experienced inflation before, so what’s different this time? To answer this question, we need some historical context so let’s journey back to the 70’s and 80’s, when inflation was previously a sticky global problem requiring innovative thinking (It was also before the surge of independent central banks). This was a time when there was comparatively plentiful fiscal hay in the respective haybarns and before globalisation taught the world that “debt is good” (apologies for misquoting Gordon Gekko, our fictional villain from Oliver Stone’s movie “Wall Street” or the non-fictional John Keynes).
Over the past 40 years, we have witnessed a trending acceptance of increased debt leverage running alongside globalisation, with the premise that as long as GDP constantly grows, debt can be perpetual. I invite the reader to ponder the global perception of debt in the 80’s compared to today with the following grid comparing the global top 10 economies with New Zealand and Australia.
With the hefty increase in debt, households are now under significant pressure as they have far less capacity to withstand the slings and arrows of outrageous monetary policy medicine, i.e., higher mortgage rates, than in the 80's.
The US has the advantage of having a comparatively longer fixed-rate mortgage market (30 years) versus New Zealand (5 years), and the average fixed-rate term of New Zealand mortgages is currently less than two years. This makes our household debt far more susceptible to rising interest rate impacts on sustainable household affordably. Simply put, New Zealand households will get a far tougher and bitter taste of monetary policy medicine through higher mortgage rates than the US. New Zealand’s household debt leverage capacity will not be supportive of our central bank’s monetary policy initiatives.
New Zealand does, however, appear to have wriggle room for carefully orchestrated government fiscal assistance to sugar-coat the RBNZ’s inflation-busting interest rate medicine.
Economic purists will voice concern that increased government spending will only fuel inflation higher, however, for economies that have already utilised their household debt leverage capacity to the max, it surely falls on governments with plenty of fiscal hay in the haybarn to start feeding it out! This wouldn’t be new for New Zealanders, as the following graph shows. Clearly, New Zealand’s government debt to GDP was leveraged to assist with the fighting of 70’s and 80’s sticky inflation (the blue line is inflation, and the black line is government debt to GDP).
Government debt to GDP is a reasonable proxy for the tightrope’s bandwidth, but countries differ in their capacity to leverage this ratio (fiscal hay capacity). For example, the US has a greater leverage capacity than, say, a country whose underlying credit rating is significantly less than the US. A crude assessment of the top 10 global economies, together with New Zealand and Australia, would indicate that only a handful can fiscally assist their respective central bankers.
The last time global inflation resembled the current inflation phenomenon, household debt was relatively unleveraged, so central banks got away with increasing mortgage rates to swindling heights to bust inflation. The situation is very different now as our households are under significantly more pressure than 40 years ago. The tightrope is very thin, which means our funambulists will need to balance their monetary policy actions more carefully or risk a nasty fall.
Christoph Schumacher and Stuart Henderson