The video explores the relationship between the classic children's story, 'The Wizard of Oz,' and the current monetary policy challenges faced by central banks like the Fed, ECB, and Bank of England. It highlights how the Covid pandemic revealed the limitations of these institutions, drawing parallels with how the "wizard" was unmasked in the story. The pandemic caused supply shocks, while government stimulus efforts triggered a surge in inflation, revealing gaps in the banks' ability to control inflation quickly.

Central banks have now managed to bring down inflation to their target levels, but they face a new landscape where older methods might not suffice. The traditional approach involves manipulating interest rates to adjust economic demand, but this might not work effectively with modern-day supply chain challenges, trade wars, climate change, and political pressures. As global dynamics shift, the role of fiscal policy, rather than solely relying on central bank strategies, is becoming increasingly significant in managing inflation.

Main takeaways from the video:

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Key Vocabularies and Common Phrases:

1. monetary policy [ˈmɑːnɪˌtɛri ˈpɒləsi] - (noun) - The process by which a government or central bank controls the money supply and interest rates to guide the economy. - Synonyms: (economic strategy, financial policy, economic regulation)

The Wizard of Oz, the classic children's story by Frank Baum, is partly about monetary policy.

2. maestros [maɪˈɛstroʊz] - (noun) - Highly skilled and influential leaders, typically used in reference to conductors of music orchestras. - Synonyms: (masters, experts, virtuosos)

We thought they were maestros, all powerful geniuses.

3. disinflationary [dɪsˌɪnˈfleɪʃənəri] - (adjective) - Referring to a reduction in the rate of inflation. - Synonyms: (inflation control, price stabilization, deflationary)

China's entry into the global trade system was a major disinflationary shock.

4. deglobalization [ˌdiːˌɡləʊbəlaɪˈzeɪʃən] - (noun) - The reduction of interdependence and integration between popular economies and societies around the world. - Synonyms: (nationalism, isolationism, anti-globalization)

The globalization tailwind for disinflation is turning into a deglobalization driver of higher prices.

5. fiscal policy [ˈfɪskəl ˈpɒləsi] - (noun) - Government policies regarding taxation and public spending to influence the economy. - Synonyms: (economic legislation, taxation policy, spending policy)

fiscal policy can tax policy can.

6. soft landing [sɔft ˈlændɪŋ] - (noun) - An economic state where growth slows but does not lead to recession. - Synonyms: (gentle slowdown, controlled deceleration, measured easing)

Since World War Two, the fed had only been able to successfully generate a soft landing, perhaps once in 1995.

7. lionized [ˈlaɪəˌnaɪzd] - (verb) - To treat someone as a very important and celebrated figure. - Synonyms: (glorified, honored, exalted)

Yet he was still lionized for slaying the inflation dragon.

8. supply shock [səˈplaɪ ʃɒk] - (noun) - An unexpected event that suddenly changes the supply of a product or commodity, resulting in changes in price. - Synonyms: (supply disruption, market disturbance, economic upset)

The lockdowns of the pandemic caused severe supply shocks as factories shuttered around the world.

9. price stability [praɪs ˌsteɪbəˈlɪti] - (noun) - Avoiding long-term inflation or deflation, maintaining relatively stable overall price levels. - Synonyms: (price moderation, inflation control, stable pricing)

Powell was very clear that they will do whatever it takes to bring price stability back.

10. remit [rɪˈmɪt] - (noun) - An area of responsibility or authority. - Synonyms: (jurisdiction, scope, range)

And many of those tools are being built outside of the remit of central banks.

Navigating Monetary Policy in a Changing World

The Wizard of Oz, the classic children's story by Frank Baum, is partly about monetary policy. There's a famous moment where Dorothy's dog, Toto pulls back the curtain and reveals the wizard to be just a man with a loud speaker. In a way, the Covid pandemic and the inflation that followed has been a Wizard of Oz moment for the Fed and the ECB and the Bank of England and other central banks. We thought they were maestros, all powerful geniuses. Then came the Covid shock.

The lockdowns of the pandemic caused severe supply shocks as factories shuttered around the world. Meanwhile, government stimulus meant to keep the economy afloat drove a surge in inflation. Central bankers were slow to recognize that inflation was taking off. And after it did take off, they didn't have the tools to bring it quickly under control. To the Fed's credit, when they decide they had to make this course correction by raising rates rapidly, they did go for it. Powell was very clear that they will do whatever it takes to bring price stability back.

I think right now many people thought that the Fed has redeemed themselves. But at the same time, the world has changed. Central banks have won the battle to get inflation back to their 2% target. In the years ahead, we may discover that they have lost the war over how management of inflation works. When interest rates go up, it becomes more expensive to borrow. And that means less spending, less demand, the economy cools and inflation comes down. And when the problem isn't too much inflation, but rather too much unemployment, central banks do the reverse. They cut interest rates. They make it cheaper to borrow. And that increases demand and it gets the economy going and creates more job opportunities.

I would compare monetary policy, as the Fed manipulating a kite. Ultimately it's at the end of that kite which really affects the economy. In the U.S., to ensure that banks have enough money to cover withdrawals, they are required to keep some reserve cash with the Federal Reserve. The Fed's policy tool is an interest rate called the Federal Funds Policy Rate. And so by changing that fed funds rate level, it will affect the short term interest rate that banks would charge at each other and eventually to other small businesses or large businesses.

Central banks controlling the flow of credit has been the preferred method of governments to assure price stability for decades. But trade wars, actual wars and climate change means the new risk to inflation comes from supply shocks. China's entry into the global trade system was a major disinflationary shock. That is not the world we are living in anymore. China is getting more expensive and frictions between China and the United States means that globalization tailwind for disinflation is turning into a deglobalization driver of higher prices.

We now live in a world of hot wars. Russia invading Ukraine and turning off gas supplies and oil supplies for Europe, an expanding conflict in the Middle East. End of lockdown and inflation was amplified by higher energy prices, especially in Europe, but also around the world. Climate change is also part of the picture. Carbon taxes would help with the fight against climate change, but they would also be adding to inflationary pressure.

The Fed's policy tools can only raise or lower aggregate demand. It is not meant to affect supply in the economy. So what can affect supply in the economy? Well, fiscal policy can tax policy can. So there's a big debate underway about what new tools are required to control prices and keep inflation low and stable. And many of those tools are being built outside of the remit of central banks.

The pandemic economy has proved to be unlike any other. There remains much to be learned from this extraordinary period. One lesson for central banks is that keeping inflation on target is going to get tougher to do. We've just been through a period where inflation didn't stay at that 2% target. And that's a world where the political support for strong, independent central banks is far from guaranteed.

There are troubling signs that unemployment is starting to rise. And that means it's a turning point for the US economy and a turning point for the Federal Reserve. What happens to the status of the fed under a second Donald Trump presidency? Would the fed retain its strength and its independence, or would it find itself subject to greater political pressure to set monetary policy according to the electoral calendar?

We estimate that 80% of the consumers are feeling financially stretched, people are paying, well over 20% on the credit card bill. And so once the fed start cutting rates, then interest rate on the credit cards would come down. But at the same time, if the Fed generates a recession and if you lose your job, then how are you going to pay?

This is the reason why it's kind of critical for Powell to, restore price stability and generate a soft landing. Since World War Two, the fed had only been able to successfully generate a soft landing, perhaps once in 1995. Alan Greenspan was the Fed chairman. And then with Paul Volcker, he did exactly the opposite. He actually, brought forth a very deep recession in the U.S. economy in the 80s. Yet he was still lionized for slaying the inflation dragon.

The lessons from Volcker and Greenspan is that a central bank's reputation really depends on whether they prove to be steady, hands on keeping price stability under control while allowing the economy to grow. And the unfortunate thing is I think Powell today still faces a tension between high inflation risks and also lower growth. We're living in a world which has swung from globalization to deglobalization, and where climate change is a new and important factor.

I think in the future, we're not going to be talking about maestros. And central banks might be the captain of the team, but they won't be the only player.

Economics, Finance, Politics, Central Banks, Inflation Management, Supply Chain Challenges