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From Storm Riders to Choosing a Rule: Jackson Hole Research Wrap

Matthew Boesler

(Bloomberg) -- Central bankers who attended this year’s policy symposium in Jackson Hole, Wyoming, have a lot to mull over as they head home from their annual retreat.

Hosted by the Kansas City Federal Reserve Bank, this year’s conference examined the timely issue of challenges facing monetary policy as officials confront slowing global growth stemming from uncertainty over trade policy.

With the gathering under way, U.S. President Donald Trump escalated the pressure on China and also pondered on Twitter whether Fed Chairman Jerome Powell was perhaps a bigger “enemy” than Chinese President Xi Jinping.

A series of academic papers were presented over the course of Friday and Saturday conference. Here’s a quick run-down of what the audience heard:

Riders on the Storm

Central bankers are like “riders on the storm,” their policies buffeted by global forces beyond their control.

Or so says a paper by that name presented on Friday.

In it, economists Oscar Jorda of the San Francisco Fed and Alan Taylor of the University of California, Davis, argued that central banks which ignore global interest rate trends risk generating imbalances and credit dislocations in their own economies.

The research has some relevance for Fed officials today, as they struggle over what policy changes, if any, to make in response to weakening economies and falling interest rates overseas, and a rising dollar.

World’s Central Bank

While Powell and his colleagues don’t want the Fed to be viewed as the world’s central bank, their monetary policy has huge ripple effects on economies in Europe and Asia, with an especially large impact on emerging markets.

University of Maryland economist Sebnem Kalemli-Ozcan, in a review of policy implications, found that Fed interest rate changes have a “large spillover effects” on emerging markets, affecting capital flows, domestic borrowing and exchange rates.

Developing countries can partly mitigate the impact of U.S. rate changes by having a flexible, as opposed to a fixed, currency, the economist writes in “U.S. Monetary Policy and International Risk Spillovers.”

Choose a Rule

Former Fed economist and European Central Bank policy maker Athanasios Orphanides renewed the argument for central bankers to set interest rates by following a formulaic rule.

“Monetary policy is most effective when it is formulated in a systematic manner, following a clearly communicated monetary policy rule,” Orphanides wrote in a paper he presented on Friday.

A long-time proponent of such policy formulas, Orphanides argued that choosing a simple rule as a benchmark would help the Fed communicate its reasons for interest-rate movements and shield it from the perception that it was influenced by political pressure. That’s a timely point as the Fed has been under relentless pressure from Trump to lower rates to help boost growth in the U.S.

Curse of Commodities

It wasn’t just the major central banks in advanced economies trying to figure out what lies ahead for them; monetary policy makers in emerging markets were pondering their own challenges.

Saturday’s session kicked off with a paper examining how central bankers in small, open economies in which commodity exports comprise a significant share of economic activity -- such as Chile or Argentina -- might respond to booms and busts in raw material prices. These have become more frequent in recent decades as commodities have become more important as investment products for global portfolio managers.

The authors -- Thomas Drechsel of the University of Maryland and Michael McLeay and Silvana Tenreyro of the Bank of England -- outlined how an increase in global commodity prices can lead to financial booms in exporting countries. That’s because the rise in prices allows them to borrow more. In turn, that pushes up their exchange rates and domestic inflation.

Triffin’s Dilemma Redux

In the 1960s, Yale economist Robert Triffin famously warned about the contradiction at the heart of a global monetary system organized around the gold standard: a fixed supply of gold in a growing global economy would eventually cause a crisis.

It was known as Triffin’s Dilemma, and sure enough, by 1971, U.S. President Richard Nixon was forced to close the gold window, ending the shiny yellow metal’s dominance in the global financial system.

The second paper presented Saturday suggested that the dilemma has returned, but in a different form: this time, U.S. dollar-denominated debt is the new gold.

Stanford University economists Arvind Krishnamurthy and Hanno Lustig pointed to the role dollar-denominated investments -- especially U.S. Treasury securities -- play in providing global investors safe assets.

They found that increased demand for such investments, as well as tighter U.S. monetary policy, causes an appreciation in the U.S. dollar exchange rate against other currencies.

But unlike gold, providing more safe assets under the dollar system means borrowers have to take on more debt.

“The supply of safe dollar assets is no longer backed by gold; however, the supply is fueled by increases in public and private leverage,” Krishnamurthy and Lustig wrote. “Will dollar leverage be supplied in a manner consistent with financial stability? The events of the last 15 years suggest that policy makers should pay close attention to this question.

--With assistance from Rich Miller, Steve Matthews and Christopher Condon.

To contact the reporter on this story: Matthew Boesler in Jackson Hole, Wyoming at mboesler1@bloomberg.net

To contact the editors responsible for this story: Alister Bull at abull7@bloomberg.net, Ros Krasny

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