For release on delivery
7:30 p.m. EDT (9:00 a.m., July 11, local time)
July 10, 2024

Common Inflation and Monetary Policy Challenges across Countries

Remarks by
Lisa D. Cook
Member
Board of Governors of the Federal Reserve System
at the
Australian Conference of Economists 2024

Adelaide, Australia

July 11, 2024

Thank you, Jacky. Iam happy to be here in Adelaide and appreciate the
opportunity to speak with all of you.! Considering the significant developments in the
global economy over the past few years, now is an appropriate time to reflect on the
economic reverberations the COVID-19 shock caused around the world. Examining the
common inflation experiences and monetary policy challenges across several countries,
including Australia and the United States, is a helpful exercise for policymakers and
economists alike. Today, I will first talk about how monetary policymakers responded in
similar fashion to the COVID-19 pandemic and, later, to high inflation during the
recovery. I will discuss common features of the recent inflation experience across
countries and the importance of global shocks. With disinflation in train across most
countries, I will consider what we can learn from past cycles of monetary easing. I will
finish with a discussion of how the use of alternative scenarios could help monetary
policymakers communicate how they might respond to a range of possible economic
outcomes.

Common Monetary Policy Response to the Pandemic

In the spring of 2020, economies around the world shut down or sharply limited
business activity, especially for in-person services, including dining out and traveling.
Governments introduced extraordinary fiscal support aimed at alleviating the
socioeconomic effects of the pandemic. And, to prevent sharp financial and economic
deterioration, most central banks responded aggressively by lowering policy rates,
ramping up asset purchases, and taking other actions to support the flow of credit to

households and businesses. Those efforts were sustained throughout 2020 and much of

' The views expressed here are my own and not necessarily those of my colleagues on the Federal Open
Market Committee.

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2021, as the initial turmoil in financial markets subsided but the health situation remained
uncertain.

Advanced economy central banks that had positive policy rates before the
pandemic, including the Fed and the central banks of Australia, Canada, and the United
Kingdom, cut these rates to near zero, as shown in figure 1. Central banks that entered
the pandemic with policy rates already at zero, such as Sweden, or negative-including
the euro area, Japan, and Switzerland-teft their rates unchanged. Meanwhile, almost all
emerging market economy (EME) central banks cut their policy rates. Although central
banks acted quickly to reduce rates, policymakers cited a few reasons to refrain from
deeper cuts: Among EME policymakers, concerns were expressed that further lowering
rates risked exacerbating capital outflows, while some advanced economy central banks
commented that further rate cuts, particularly in negative territory, could harm banks'
financial health or would provide little additional monetary stimulus.

Many central banks also conducted significant asset purchases. These purchases
were initially aimed at restoring market functioning and providing liquidity, but they also
were seen as lowering long-term yields and easing broader financial conditions. The Fed
and the Bank of England (BOE) restarted their purchases, while the European Central
Bank (ECB) and the Swedish Riksbank increased the pace of their existing programs.
And here, the Reserve Bank of Australia began asset purchases and introduced a target
for the three-year government bond yield at the same level as its overnight rate.

The Rise of Inflation and the Common Monetary Policy Response
Over the course of 2021, as financial conditions improved, a strong recovery in

consumer demand outpaced still constrained supply capacity in many countries, leading

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to production and transportation bottlenecks, which ultimately resulted in inflation. The
surge in inflation was initially mostly concentrated in finished goods and commodities
but later spread to services." As the economy started reopening with the lifting of
lockdowns and rollout of vaccines, demand for services picked up. Similar to what
played out with goods, the pickup in demand for services ran into a constrained supply of
service workers. As services are more labor intensive than goods, and labor supply was
still reeling from the consequences of the pandemic, the rebalancing of consumption from
goods to services led to higher rates of inflation and nominal wage growth.

In response to rising inflation, central banks around the world started to remove
some of the support that they provided during the height of the pandemic. As a first step,
central banks let many of the emergency support programs-in which they had bought
assets other than national government bonds-expire. Next, central banks generally
began to taper their purchases of government securities and then to end net purchases late
in 2021 or the first half of 2022.

Then some central banks began to raise interest rates. The first to do so were
EME central banks that saw particularly sharp increases in inflation driven by exchange
rate depreciation and by the surge in prices for food, which makes up a large part of the
consumption baskets in their economies. Advanced economy central banks generally
were more patient on raising interest rates in 2021, as inflation expectations in their
economies were better anchored than in emerging economies. Among advanced

economy central banks, the first to hike in the autumn of 2021 were central banks in

> See Francois de Soyres, Alexandre Gaillard, Ana Maria Santacreu, and Dylan Moore (2024), "Supply
Disruptions and Fiscal Stimulus: Transmission through Global Value Chains," AEA Papers and
Proceedings, vol. 114 (May), pp. 112-17.

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Norway and New Zealand, whose economies had strong recoveries. The BOE first raised
its policy rate in December 2021, citing a strong labor market and sharply rising inflation.
The Bank of Canada and the Fed began to raise rates in March 2022, and the ECB first
raised its deposit rate (from negative 0.5 percent to zero) in July 2022. Most advanced
economy central banks undertook a sequence of policy actions in which they first began
to raise their policy rates and later began to reduce the size of their balance sheets over
time.

Understanding the Rise and Fall of Inflation in Recent Years

The inflation surge in the aftermath of the COVID-19 pandemic was
synchronized across advanced and emerging economies, as figure 2 illustrates. The rapid
increase in prices reflected an upswing in demand for goods, strained supply chains, tight
labor markets, and sharp hikes in commodity prices exacerbated by Russia's February
2022 invasion of Ukraine. The run-up was not only for overall headline inflation, but
also for its core components.

A plethora of factors can explain the global co-movement in headline and core
inflation. First, fluctuations in global food and energy prices broadly pass through to
consumer prices in individual countries. But there are other possible explanations,
including global supply constraints and synchronous policy responses. The pandemic
experience was also a stark reminder of the importance of international trade and input-
output linkages for the propagation of supply shocks-for example, production and
shipping disruptions in the semiconductor industry in Asia constraining production and
creating important price pressures in downstream markets, such as motor vehicles in the

US.

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Research on the recent inflation episode is still very much in its infancy, and I
look forward to learning from the ongoing work on the subject. One important
contribution already is Ben Bernanke and Olivier Blanchard's analysis of pandemic-era
inflation in 11 economies. Separate teams for each of the 11 economies estimated a
comparable model of inflation and its drivers. They find for the U.S. and, with some
variation, for other countries that "relative price shocks and sectoral shortages drove the
initial surge in inflation, but as these effects have reversed, tight labor markets in most
(although not all) countries have become a relatively more important factor."

In a recent FEDS Notes article, economists at the Federal Reserve Board took
head-on the task of decomposing world inflation into common and country-specific
components and using this decomposition to analyze the sources of inflation around the
world.* Despite the different approach, they reached conclusions broadly in line with
those of Bernanke and Blanchard. As shown in figure 3, they find that the global
components of inflation accounted for a large part of the variation in the average inflation
around the world during the post-COVID period. This is an experience with precedents
during the oil price shocks of the 1970s and the 1980s.

This study also found that the global components of inflation also predict the path
of near-term inflation. Historically, once global components start moving, they maintain
the course and take time to reverse. This persistence and the recent decline in global

components of core and noncore inflation suggest that the world disinflationary process

3 See Ben Bernanke and Olivier Blanchard (2024), "An Analysis of Pandemic-Era Inflation in 11
Economies," Hutchins Center Working Paper 91 (Washington: Brookings Institution, May), quoted text on
p. 1, https://www.brookings.edu/wp-content/uploads/2024/05/WP91_Bernanke-Blanchard.pdf.

4 See Danilo Cascaldi-Garcia, Luca Guerrieri, Matteo Iacoviello, and Michele Modugno (2024), "Lessons
from the Co-Movement of Inflation around the World," FEDS Notes (Washington: Board of Governors of
the Federal Reserve System, June 28), https://www.federalreserve.gov/econres/notes/feds-notes/lessons-
from-the-co-movement-of-inflation-around-the-world-20240628.html.

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will continue, as shown in figure 4. The predicted path is in line with a gradual return of
inflation toward central bank targets.

Of note, as shown in figure 5, the authors find that the post-pandemic rise in
global inflation was linked to both commodity-driven price shocks and shocks to global
economic activity-such as the sharp decline and rebound in activity due to the
COVID-19 pandemic and the associated labor market shortages. This situation contrasts
with the 1970s and 1980s, when commodity price shocks played a prominent role in
inflation's fluctuations. Additionally, idiosyncratic shocks were important drivers of the
surge in global inflation in 2022 and its decline in 2023. These shocks may capture
economy-specific forces, including natural gas disruptions that more greatly affected
European economies than others in the aftermath of Russia's war on Ukraine.

In sum, through the lens of the model, the ongoing disinflation is driven by
waning effects of commodity price shocks and by a gradual normalization of global
economic activity, amid the resolution of shortages and imbalances in labor markets.
Current Common Monetary Policy Challenges

With global components of inflation turning down, most countries have
experienced a significant fall in inflation relative to its peak. Similarly, most central
banks stopped raising their policy rates over the past year. Some are considering how
long to keep rates at restrictive levels or, if inflation picks up again, whether to raise rates
further. The Bank of Canada, the ECB, the Swedish Riksbank, and the Swiss National
Bank, have begun to cut policy rates, highlighting progress toward meeting inflation
goals amid sustained softness in economic activity. Indeed, unlike in the U.S., the level

of gross domestic product (GDP) in some advanced economies remains well below what

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would be implied by their respective pre-COVID GDP trends.° Even among those
cutting rates, however, the future path of the policy rate is generally seen as dependent on
a continuing decline of inflation toward target levels.

For all central banks, the question is how best to ensure continued disinflation
while avoiding unnecessary damage to the economy. The generally desired outcome is a
soft landing, in which inflation returns to the central bank's target inflation level or range
without inducing a recession or a large increase in unemployment. How likely is such a
scenario? It may be too soon to definitively say for the current economic cycle. But Fed
Board staff have examined past episodes of monetary policy easing in 13 advanced
economies over the past five decades. They find that soft landings are rare, according to
their analysis published in another recent FEDS Notes article.® In most of the cases that
they studied, central banks were not successful in bringing inflation back to near target in
a timely manner. And when they were successful in taming inflation, it often was
associated with a recession.

However, soft landings are not unprecedented. When such a landing occurred, on
average it was associated with a smaller preceding policy tightening. Soft landings were
also more likely when policy easing began with inflation already close to target and when
there was a relatively firm growth backdrop. In the U.S., what I have seen so far appears

to be consistent with a soft landing: Inflation has fallen significantly from its peak, and

5 See Francois de Soyres, Joaquin Garcia-~Cabo Herrero, Nils Goernemann, Sharon Jeon, Grace Lofstrom,
and Dylan Moore (2024), "Why Is the U.S. GDP Recovering Faster Than Other Advanced Economies?"
FEDS Notes (Washington: Board of Governors of the Federal Reserve System, May 17),
https://doi.org/10.17016/2380-7172.3495.

® See Francois de Soyres and Zina Saijid (2024), "Lessons from Past Monetary Easing Cycles," FEDS
Notes (Washington: Board of Governors of the Federal Reserve System, May 31),
https://doi.org/10.17016/2380-7172.3504.

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the labor market has gradually cooled but remains strong. Of course, I am closely
monitoring incoming data to see how the economy further develops.

It is possible that some features of the recent inflation episode may make a soft
landing more likely in countries around the globe. As I discussed, Bernanke and
Blanchard found that much of the inflation episode came from relative price shocks and
sectoral shortages that have since been resolved. And while they found that tight labor
markets have since taken over as the main drivers of inflation, there are signs that such
tightness is easing. For instance, in the U.S., the ratio of vacancies to unemployment has
fallen back to its pre-pandemic level and the rate of voluntary quits has declined, as
workers are less confident of finding a better job. Thus, my baseline forecast (and that of
many outside observers) is that inflation will continue to move toward target over time,
without much further rise in unemployment.

Monetary Policy Communications

Of course, forecasts are subject to considerable uncertainty, and policymakers
must consider a range of possible outcomes. A key challenge of monetary policy
communications is discussing how policy would respond to changes in the economic
outlook. Central bankers are faced with a tradeoff between predictability and flexibility.
On the one hand, many observers would like to know in advance what the path for the
policy rate will be, while, on the other hand, a central bank needs to remain nimble and
data dependent. As a result, central bankers often try to convey their "reaction function"
so observers understand how policy might adapt to incoming data and the implications

for the economic outlook.

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In his recent review of forecasting for monetary policymaking and
communications at the BOE, Ben Bernanke suggested that the Bank consider
supplementing its published forecasts with the use of alternative scenarios to help the
public understand its policy reaction function.' For similar reasons I try to incorporate a
discussion of alternative scenarios in my own speeches. Fed policymakers, like those at
many other central banks, also benefit from staff analysis using models to explore how
the forecast would change relative to the baseline if certain assumptions are changed.
The challenge is how to use such alternative scenarios in our official communications.

Policy communications are an area where we can learn a lot from what other
central banks have done, and communication practices have developed over time. The
BOE was an early innovator with its fan charts, which emphasized that its forecasts for
GDP and inflation were subject to growing uncertainty the longer the time horizon. Of
course, forecasts for economic variables need to be conditioned on some assumption of
the path of policy rates. While early practice was to condition on unchanged rates or on
the path of rates implied by market pricing, some central banks innovated by publishing
their own forecasts for policy rates. This was originally done by the Reserve Bank of
New Zealand and later by the Norges Bank and the Riksbank. Since 2012, the Federal
Reserve's Summary of Economic Projections also includes the path of the policy rate that
each policymaker "deems most likely to foster outcomes for economic activity and

inflation that best satisfy his or her individual interpretation of the statutory mandate to

7 See Ben S. Bernanke (2024), Forecasting for Monetary Policy Making and Communication at the Bank of
England: A Review (London: Bank of England, April), https://www.bankofengland.co.uk/independent-
evaluation-office/forecasting-for-monetary-policy-making-and-communication-at-the-bank-of-england-a-
review/forecasting-for-monetary-policy-making-and-communication-at-the-bank-of-england-a-review.

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promote maximum employment and price stability."* I continue to take great interest in
communications and other monetary policy practices by foreign central banks.

In conclusion, I think it is clear we have learned much from the experience of the
past few years. I must stress that the human toll of the pandemic cannot and should not
be overlooked. Purely in terms of economics, the recent period does stand out as an
unusual case study. Economies around the world effectively faced the same shock at
nearly the same moment. We were then able to observe how various economies around
the world responded to the shock, including the actions of central banks and fiscal
policymakers. I am glad to have highlighted some of the interesting research that has
begun to explore this space, and I am sure much more study on this unique time in our
history will soon occur, and that can be powerful. What is not unique to the pandemic is
that we often have common macroeconomic experiences and face common monetary
policy challenges, which is what makes discussions like the one today so valuable.

Thank you. It is a pleasure to be here in Adelaide. I look forward to continuing

our conversation.

8 See the June 2024 Summary of Economic Projections (quoted text on p. 1), available on the Board's
website at https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20240612.pdf.

Common Inflation and Monetary
Policy Challenges Across Countries

LISA D. COOK
MEMBER, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
PRESENTATION TO THE AUSTRALIAN CONFERENCE OF ECONOMISTS

JULY 11, 2024


Figure 1: Policy Rates across Selected Advanced Economies

--- Australia
- Canada
- Euro area
- - Japan
--: UK.

- US.

Percent

Lt
2009

I
2012

Lt Lt
2015 2018

Note: Data extend through July 2024.
Source: National sources via Haver Analytics.

I__I
2021

I I I -1
2024

Figure 2:

Headline Inflation

=- Australia « « U.K.
- == Germany U.S.
- = Korea
- + Mexico

== World

Inflation across Selected Economies since 2008

4-quarter percent change

dojo pp
2008 2010 2012 2014 2016 2018 2020 2022 2024

12

10

2

Core Inflation

=- Australia « - U.K.
= = Germany U.S.
= = Korea

» +» Mexico

== World

4-quarter percent change

ee ee {I I I I -
2008 2010 2012 2014 2016 2018 2020 2022 2024

Note: Inflation series are 4-quarter percent changes of consumer price indexes, and world inflation is GDP-weighted 4-quarter percent
change of consumer price indexes for selected economies. Data extend through 2024:Q1. Shaded area refers to period in which the World
Health Organization declared COVID-19 a public health emergency. World inflation, the red line, isa GDP-weighted average of the
inflation measures for 26 economies.

Source: National sources via Haver Analytics; FRB staff calculations; World Health Organization.

8

2

Figure 3: Global Components of World Inflation

Headline Core Noncore

4-quarter percent change

4-quarter percent change 1 4-quarter percent change 1

l
[oe]
l
a
foe)
1
foe)

- World headline inflation - World core inflation - World noncore inflation
== Global component

== Global component 415 ==Global component I 15

= 4 -6 = 4 -6 =

Pi ty I yp ty ty tf ptr tsrtytytirtieg I J
73 1983 1993 2003 2013 2023 1963 1973 1983 1993 2003 2013 2023 9 1963 1973 1983 1993 2003 2013 2023 2

1963 19

Note: World inflation is the GDP (gross domestic product)-weighted, 4-quarter percent change of consumer price indexes for selected
economies. Global components are GDP-weighted aggregates of each economy's common component. Noncore inflation encompasses food and
energy categories. Headline inflation is the aggregate of core and noncore inflation using economy-specific weights. Data extend through
2024:Q1.

Source: National sources via Haver Analytics; Federal Reserve Board staff calculations.

Figure 4: Model-Based Forecast of the Global Components of Inflation

4-quarter percent change

9
= = = Core
Headline
= = Noncore
6
3
0
3

2019 2021 2023 2025 2027

Note: Global components are GDP (gross domestic product)-weighted components estimated through a factor model that isolates co-movement
from economy-specific trends and transitory movements. Noncore inflation encompasses food and energy categories. Forecast shown is derived
from the factor model and driven by the statistical persistence of the global components. Headline global component is the weighted average of core
and noncore global components using economy-specific weights. Data extend through 2027:Q4. Shaded area refers to the forecast period.

Source: National sources via Haver Analytics; Federal Reserve Board staff calculations.

Figure 5: Drivers of World Headline Inflation

1970s to Early 1980s 2020s
Deviation from 1972:Q4 Deviation from 2019:Q4
Percentage points Percentage points
- World headline inflation 16 - World headline inflation 79
Idiosyncratic shocks Idiosyncratic shocks
Commodity shocks 42 Commodity shocks
Global activity shocks Global activity shocks
8
4
0
4 phlipiutipyitipyitipritis.s
1973 1975 1977 1979 1981 1983 2020 2021 2022 2023

Note: Figure 4 illustrates decomposition for selected inflationary periods stemming from vector autoregressive models estimated from
1961:Q1 to 1994:Q4 (left panel) and from 1995:Q1 to 2024:Q1 (right panel). Global component of headline inflation and its decomposition are
constructed from economy-specific core inflation weights and aggregated with gross domestic product (GDP) weights. Global activity shocks
combine shocks to the global component of core inflation, to global GDP, and to labor market shortages. Commodity shocks combine shocks to
the global component of noncore inflation, to oil prices, and to global commodity prices. Noncore inflation encompasses food and energy
categories. Data extend through 2024:Q1.

Source: National sources via Haver Analytics; Federal Reserve Board staff calculations.