Despite the hawkish stance of major central banks led by the Fed and recently the BoJ, the global geopolitical uncertainties limit hawkish stance in the rest of the world. There is even a growing divergence between monetary policies of the US and the other developed economies. The Fed stands out. China, which unlike the US continues to keep its monetary policy loose, is another good example of this divergence.

Accordingly, the global rate gaps have lately been rising, both between the advanced world economies and the developing world economies, as well as amongst the advanced world economies. From neutral to negative and to the substantially positive rate rises, global rate paths are diverging. The gaps between policy rates in the US and the rest of the world are a critical benchmark here. Volatility in the dollar index (DXY) is good proof of this divergence.

Thus, the diverse economic dynamics and differing policy approaches among the world economies are a new reality. And central banks face a policy trilemma of maintaining low and stable inflation, fostering robust and inclusive growth and ensuring financial market stability. They surely need a highly coordinated policy approach, one that maintains fiscal stability while significantly enhancing supply responsiveness, productivity, labor market functioning as well as regional, global policy coordination.

Search for and adjustment to a (post-pandemic and post-tariff) new normal has also been dominating policy discussions for a while now. Monetary policy divergence and altering policy approaches to the anomalies of the post-trade war, post-pandemic and post-Great Recession (and the topsy-turvy new normal) are already increasing across the central banks.

Monetary policy is even taking a rather accommodative stance after the Great Recession, the Pandemic of 2020 and the ongoing trade wars. Central banks around the world may be in a consistent policy dilemma to decide between the trade-off between rising inflation figures and the risks of recession. Stagflationary risks from rising energy prices and geopolitical risks, as well as the contagion effect of the tussle of the elephants is another major risk to bear in mind.

In particular, the ongoing geopolitical tensions, trade wars, and the resulting soaring energy and food prices are all leading to a new high-inflation era, reminiscent of the cost-push shocks of the 1970s. Following this surging inflation trend, central banks are shifting their focus away from growth and concentrating more on price stability.

Supply chain issues, tariff wars, the war in Ukraine, tension in the Middle East and China Sea are all leading to new supply chain breaks. And these supply chain disruptions and decreasing production, as well as surging demand during the past few years have all led to a new inflationary cycle. Ongoing tariff wars and record high inflation rates itself grow concerns regarding a new global recession cycle.

Monetary policy may even work a little differently in emerging markets and developing economies. Demand might matter much less compared to their advanced economy counterparts, where production capacity is ready to meet any demand it faces (just as predicted by Mr. Keynes?). In the emerging markets and developing economies, though, you might always need to build new production capacity and create new employment opportunities (just as in the Bretton Woods-II argument for China).

After all, new research even demonstrates that policy-rates may not matter much in developing economies either. Policy literature even shows that, at least in certain cases, policy rates may not affect either the market rates or the real economy (at all). Since domestic savings are usually very low, in many developing economies, capital inflows may be more effective over market rates in these emerging markets.

Furthermore, just as once argued by IMF chief economist Gopinath, the main reason for the diverging monetary policy approaches of the Fed and ECB might be ‘energy’ itself. After all, Europe is a major energy importer and is substantially negatively impacted by rising energy prices. The US, on the other hand, has no such dependency. In fact, the US is a net energy exporter and hence even benefits from surging energy prices.

The Euro Area and the UK are more exposed to the energy crisis and the war in Ukraine, for instance. Thus, following upon the policy divergence in countries like China-Japan-Türkiye vs. the US-Europe, a new sort of policy separation between the US and Europe seems to be evident, as of today. Real-world shocks lead to this sort of inevitable results.

Meanwhile, most emerging market economies might follow expansionary policies in any case. The idea is that with loose monetary policy and lower cost of borrowing, firms may be able to access cheaper loans, and hence, more investment and production will follow. Rising supply and lower cost of production (input or finance cost and economies of scale), in return, will decrease prices, and hence, much lower inflation. Export and employment rises should follow.

In that sense, the focus of central banks in the advanced world economies is usually primarily on nominal factors, and predominantly focusing on bringing down the inflation rate. On the other hand, central banks in most developing economies including China focus on real targets such as encouraging growth and increasing employment.

It should also be underlined that strong national currencies (in the advanced economies, in particular) are mainly used to fight this high inflation figures and keep prices stable. Though, strong dollar and other reserve currencies may also lead to widespread inflationary trends around the world. Thus, these cross-country nominal volatilities also matter.

Just to make sure; inflation-adjusted accounts (e.g. real rates) are surely the crux of the matter. They are more accurate, more realistic, and more rational approaches. Yet, despite the fact, market realities often force investors to make nominal comparisons due to the ease of use and the need for rapid measurement and the ability to make arbitrage calculations. The markets would, hence, just look at nominal interest rates, get an idea, and move on. And hence, the focus on all these nominal volatilities.

References:

Bagis, B. (2017). Monetary Policy Divergence and Central Banking in the New Era. In: Dinçer, H., Hacioğlu, Ü. (eds) Risk Management, Strategic Thinking and Leadership in the Financial Services Industry . Contributions to Management Science. Springer, Cham. https://doi.org/10.1007/978-3-319-47172-3_3

Bagis, B. (2023). “Central Banking notes and publications”, EcoPoitics Cafe, Avaliable at:  https://bilalbagis.wordpress.com/2023/03/25/central-banking/

Bagis, B. (2022). “Monetary Policy and Interest Rates notes & publications”, EcoPoitics Cafe, Avaliable at: https://bilalbagis.wordpress.com/2022/10/26/monetary-policy-and-interest-rates-notes-publications/

Bagis, B. (2022). “Digital Currencies & Payment Systems notes and publications”, EcoPoitics Cafe, Avaliable at: https://bilalbagis.wordpress.com/2022/12/30/dijital-paralar-ve-odeme-sistemleri-digital-currencies-payment-systems/

Bagis, B. (2022). “Para politikasında ayrışma”, EcoPoitics Cafe, Avaliable at:  https://bilalbagis.wordpress.com/2022/04/29/para-politikasinda-ayrisma/