LONDON (Reuters Breakingviews) - A new breed of central bankers is emerging. They speak plainly and are less steeped in economic theories than recent predecessors. That has benefits but also means it is harder to predict how they will react.
Take U.S. Federal Reserve Chairman Jerome Powell. Like Christine Lagarde, named last week as the next European Central Bank president, he is a lawyer by training, with experience in government. The American in 2018 warned against placing too much trust in some of the economic models that had guided U.S. monetary policy. He made it clear he would rely more on the evidence of incoming data, a notion underscored in his testimony this week to Congress. That may also be Lagarde’s inclination once she is in Frankfurt.
This approach has advantages. Some theoretical concepts, such as the neutral level of real interest rates – a Goldilocks state in which monetary conditions are neither too tight nor too loose – are tough to explain and estimate. And they change as the structure of the economy evolves, so being dogmatic about them is unwise.
Granted, even central bankers with academic economics backgrounds aren’t necessarily doctrinaire. There are plenty who acknowledge that old relationships, for example between inflation and unemployment, may be in flux. And outgoing ECB President Mario Draghi, a former professor of economics, is one rate-setter whose familiarity with the dismal science has helped rather than hindered policymaking.
But for investors there’s a difference between, say, Powell’s fluid thinking and that of predecessors such as Ben Bernanke, whose research on the Great Depression informed his world view. Without a known framework, it’s harder to assess how Powell or Lagarde might react to new developments or data – their reaction function, in the jargon. Hence the surprise when Powell said in January the Fed would be patient before making any further rate moves, having flagged increases as recently as December.
That shift, and another turning full circle towards potential rate cuts at upcoming Fed meetings, may be justified on economic grounds. The Fed, like the ECB, is packed with professional forecasters. But market-watchers focus, perhaps excessively, on how a central bank’s figurehead sees the world – and the likes of Powell and Lagarde are harder to read than they are used to.
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