Global Macroeconomic Coordination

I like Mario Draghi, I do not always agree with the ECB's policies but I believe that he is a very practical man that wants to see global economic conditions become better.

As a result of my views of the man, I was very interested in his latest speech yesterday at the ECB Forum on central banking in Sintra Portugal.

The speech was very instructive in that it reflected the broad thinking of the central bankers about the way in which they should do their jobs and it also allowed us a rare insight into the thinking of macroeconomic policy makers as they seek to navigate what are certainly very volatile times.

I also believe that one gets a better understanding of central banking policy from Mr. Draghi compared to Ms. Yellen as he seems to be clearer about what the central banks ought to do compared to Ms. Yellen who is far more reticent and less forthcoming.

In the speech, he spoke of three broad topics. I will first list them and then deal with the one by one through analyzing what he actually means.

Firstly, he spoke about causes and effect of the persistently low global inflation. Secondly, he spoke about the real need to deal with monetary policy spillovers i.e. the broader effects of their unconventional monetary policy and finally, he touched on a very important topic which was a need for global monetary policy alignment.

With regards to the first point, he suggested that the cause of low global inflation is due to two main factors which are low global output which is not really a surprise which is indeed what is happening across the world.

It was the second reason that surprised me, he spoke about lower energy prices playing a factor in the low inflation prices. What really surprised me was the context in which he attributed the fall in energy and commodities prices to low inflation.

He spoke about this being of a cyclical nature which is very similar to what Ms. Yellen called transitory factors but unlike Ms. Yellen, he believes that the effects on the wider economy will not be cyclical especially as it forces central banks to take unconventional actions which could lead to more spillover risks.

This shows that he is also taking the risks inherent in excessively low commodities prices very seriously.

He also spoke about structural changes in the economy and brought into play a concept that many people are aware of but hardly even consider as a reason for low interest rates.

This is the idea that as more people prepare for pensions and retirement in many parts of the world, there is a mismatch between savings over planned investments.

He also spoke of an increased demand for and lower supply of safe assets; from relatively less public capital expenditure in a context of slowing population growth in advanced economies; from the secular shift from industries intensive in physical capital to those more intensive in human capital; and from a slowdown in productivity growth that reduces returns on investment.

He makes a point that I agreed with which was that while this may not generally be the case around the world, the effects of excess savings in places like Japan, China and the Central and Northern Europe are eventually finding their way into the global financial markets and crowding out investments into safe assets and also pushing yields lower on a variety of financial market assets.

He therefore suggested that the this has pushed equilibrium rates lower and it has become the responsibility of the central banks to use their unconventional tools to stabilize and supporting domestic demand and domestic price pressure.

I did not agree with this point because while pensions and retirement funds continue to grow, it is certainly not stabilizing nor supporting to lower interest rates to negative and then proceed to inject record amounts of liquidity into the financial markets.

Surely, this will have the opposite effect of further reducing demand. On the other hand, this policy has had a significant effect on the financial markets and pushed to significant highs yet and this is the key, these fantastic sums of money being pumped into the system are not filtering down to the average SME in Europe but is in essence kept in purgatory also known as the financial markets.

The second broad topic he spoke about was the concern about unintended policy spillovers arising not from the measures employed but the intensity of which they were employed.

The main area in which he asserted that negative spillovers has taken place has been in the currency markets and at this point, he began to speak about how better international monetary policy coordination will be useful to mitigate the currency divergences that arises from the spillovers as a result of the monetary policy choices of global central banks.

The type of international monetary policy is one which will also include fiscal, macro-prudential, regulatory and supervisory policies which can help mitigate the adverse effects of foreign monetary policy on domestic financial stability.

He went further to suggest that because in his opinion the main drivers of low inflation include low energy and commodities prices, low global output and the saving and investment dilemma are all international then there should be international coordination of monetary policies to deal with them.

He further asserted that if there is a coordinated global monetary response to these challenges then we will see swifter improvements with a reduced strain on domestic policy and finally, he said that this direction was not a choice but is in fact the new reality.

I agree that there must be coordinated policy on these matters at some levels but I am skeptical about how this will work in practice because each nation has specific macroeconomic needs, I also disagree with the notion that because the problem is the same everywhere, this means that the cause and therefore the medicine should be the same.

This is not the case at all and besides, in many parts of the world, the problem is the complete opposite of low inflation and here nations are putting all their efforts into curbing inflation.

In conclusion, what we are seeing is Draghi informing the world that central banks are now working much more closely together to fight against what he sees as common enemies.

On the one hand, it will make predicting the decisions of the central banks easier to predict but on the other hand, it is likely to create more volatility as the effect of a coordinated policy will have different effects in different nation so even though, I find Mr. Draghi to be a very sensible man, I believe that he is starting to feel a bit isolated and wants global central banking coordinated action to serve as justification for his actions against those who oppose him.