Lisa D Cook: Global linkages - supply, spillovers, and common
challenge
Speech by Ms Lisa D Cook, Member of the Board of Governors of the Federal Reserve
System, at "Global Linkages in a Post-Pandemic World" 2023 Asia Economic Policy
Conference, sponsored by the Federal Reserve Bank of San Francisco Center for
Pacific Basin Studies, San Francisco, California, 16 November 2023.
* * *
1
Thank you, Sylvain, and thank you for the opportunity to speak to you today. It is fitting
and timely that today we are gathered here to talk about global linkages. It is fitting not
only because we are beside the Golden Gate-where, just a few blocks away, one can
marvel at the massive cargo ships making their way to port-but also because this
conference has once again brought together scholars and friends from as far away as
Shanghai, Atlanta, and Fontainebleau. And it is timely because the discussion of the
ties that bind us is as important as ever.
To start off this conference on global linkages, I am going to discuss supply shocks,
policy spillovers, and common challenges faced by monetary policymakers in recent
years and going forward. When the global pandemic hit in the spring of 2020,
economies around the world shut down or sharply limited activity, especially for
inperson services. Also, it quickly became apparent that shutdowns in any one economy
were exacerbated by reduced availability of supplies from other economies.
Policymakers around the world faced the common challenge of supporting incomes and
limiting the scarring from temporary shutdowns in activity. The response was similar
across countries: fiscal support, particularly to help those most in need, although the
magnitude differed, in part because of differences in fiscal space. Initially aimed at
preventing sharp financial and economic deterioration, monetary policy easing was later
extended to support the nascent economic recovery. Policy rates were cut to or held
near zero in both advanced and emerging market economies. A wide range of central
banks also bought assets to support market functioning and provide stimulus once
overnight policy rates hit their effective lower bounds.
As economies gradually reopened, demand surged, especially for goods. But supply
chains were slower to recover, leading to a global surge in inflation. That surge was
followed by a further upswing in inflation after February 2022, when Russia's invasion of
Ukraine caused a shock to global supplies of commodities, including oil and natural
gas, food and fertilizers, and numerous manufacturing inputs.
With inflation unacceptably high, monetary policy turned toward tightening. Central
banks in several emerging market economies began to tighten first, seeking to prevent
a de-anchoring of inflation expectations that could cause elevated inflation to become
entrenched. Starting in March 2022, the Federal Reserve raised its policy rate 5-1/4
percentage points, and it has been shrinking the size of its balance sheet since June of
that year. Those actions have tightened U.S. financial conditions, acting to dampen U.
S. aggregate demand. Activity in the housing sector has slowed significantly, with
30year mortgage rates rising to more than 7 percent, and business spending has been
constrained by high interest rates and reduced credit availability.
Over the past year, amid tightening financial conditions globally, inflation has come
down from its peak in most economies. In the U.S., inflation (as measured by the
12month change in the personal consumption expenditures price index) has fallen from
7.1 percent in June 2022 to 3.4 percent in September of this year. Core inflation has
declined from a peak of 5.6 percent in February 2022 to 3.7 percent in September. I
believe the Federal Reserve's actions contributed to this fall in inflation both by
restraining aggregate demand and by keeping longer-term inflation expectations well
anchored.
The fall in headline inflation was helped by declines in global commodity prices from
their 2022 peaks. The spot price of Brent crude oil dropped from about $115 per barrel
in April 2022 to just over $80 most recently. Global agricultural prices also have
retreated from their peaks, though they remain elevated. These price declines occurred
partly because the supply of energy and other commodities has been less disrupted
than feared in mid-2022. In addition, the U.S. has become an increasingly important
supplier of energy on the global market, with U.S. production of crude oil and natural
gas reaching all-time high levels.
Importantly, global supply chains have largely recovered from their disruptions, with a
return to pre-pandemic levels of indicators such as the share of manufacturing inputs in
short supply. This recovery has occurred both because of supply responses motivated
by high prices for transportation and key inputs and because of a shift of demand from
goods back toward services. One big open question we will discuss at this conference
is how global supply chains have changed since the pandemic.
Supply is also a significant part of the deceleration in U.S. shelter prices. A surge in
completions of multifamily housing has contributed to the sharp slowing of rent
increases on new leases this year. That slowing will feed over time into a continued
decline of inflation in rents and owners' equivalent rents (the rents that homeowners
forgo by living in their own homes rather than renting them out), thus contributing
importantly to the expected further reduction in overall U.S. inflation.
In the U.S., labor supply, which fell because of the effects of the pandemic, has
recovered significantly over the past two years, boosted by rebounds in labor force
participation and immigration. The labor force participation rate, at 62.7 percent in
October, has increased by 0.5 percentage point over the past 12 months, while
participation of prime-age workers (those 25 to 54 years of age) has increased nearly
twice as much. As a result, the prime-age participation rate is now above its
prepandemic level and is near its highest point since 2002. The rise has been especially
strong for prime-age women, whose participation recently reached a record-high level.
Over this year, payroll growth has slowed but remained strong. And a broad set of
indicators show labor demand and labor supply coming into better balance. Currently,
there are 1.5 job openings per unemployed worker. While still a high level historically, it
is down from its peak of 2.0 early last year and is much closer to the pre-pandemic ratio
of 1.2. Quits, which soared during the pandemic, have fallen since early 2022 and were
close to their 2019 average in July, an indication that workers are less certain of finding
another job in a cooling labor market. The workweek, which rose to very high levels
during the pandemic when firms could not find enough workers, has returned to
prepandemic levels. And surveys of employers suggest that hiring and retention are not as
difficult as they were last year.
To be sure, it is a good thing that the easing in supply-demand imbalances in the labor
market and the disinflation we are seeing thus far have taken place with only a modest
increase in the unemployment rate, which was 3.9 percent in October. As I have
discussed, that favorable combination likely reflected an easing of supply constraints,
including in the labor market. I am also encouraged by the strong growth in labor
productivity over the past two quarters, which, if sustained, could contribute to further
progress toward price stability. I believe that a soft landing is possible, with continued
disinflation and a strong labor market, but it is not assured.
In setting monetary policy, we need to seek a policy stance that is sufficiently restrictive
to bring inflation back to 2 percent over time. I see risks as two sided, requiring us to
balance the risk of not tightening enough against the risk of tightening too much. We
have seen continued momentum in economic growth and consumer spending, even in
the face of monetary policy tightening over the past year and a half. There is a risk that
such continued momentum in demand could keep the economy and labor market tight
and slow the pace of disinflation.
But I am also attuned to the risk of an unnecessarily sharp decline in economic activity
and employment. Some parts of the economy are showing strain from tighter financial
conditions. Households at the lower end of the income and wealth distributions have
largely exhausted their excess savings, while delinquencies on auto loans and credit
cards have risen to pre-pandemic levels or higher. Small businesses generally borrow
for shorter terms than larger businesses, and they are facing tighter credit conditions
and higher rates as they roll over those short-term loans. Homebuilders have done
surprisingly well over the past year and a half, but they see the current level of
mortgage rates as substantially slowing demand.
As we try to identify the full, lagged effects of monetary policy tightening, I am
considering whether small businesses, the housing sector, and low- and
moderateincome households could be warning of broader stress ahead.
The linkages we are talking about today connect us in ways that are economically
beneficial but also have the potential to transmit stress. For that reason, I am also
attentive to the risk of renewed global economic shocks. In recent weeks, oil prices
have been volatile but are down from their September peaks. Amid highly elevated
geopolitical tensions, however, the risk of a sharp rise in global energy prices remains
salient. I also see signs of subdued economic growth in our major trading partners,
whose health affects U.S. economic conditions related to our dual mandate. China's
economic growth has remained below pre-pandemic rates, and activity in its property
sector has been extremely weak. In Europe, recent data point to muted growth as the
region deals with tightened financial conditions and the effects of past energy price
shocks.
The Federal Open Market Committee is, of course, focused on our dual mandate of
maximum employment and stable prices in the U.S. But I recognize that we act in a
world of global markets and strong economic linkages. I pay close attention to the
spillovers of our policies abroad and spillovers to our economy from monetary policy in
other countries. And Federal Reserve staff have done considerable work over the years
to understand and quantify these two-way spillovers. I will draw on some of that work in
the discussion that follows.
We would expect the monetary policy of one country to have spillovers to other
economies through three main channels.2
domestic demand.
The first channel works through Taking the U.S. as an example,
when U.S. monetary policy tightens, U.S. aggregate demand slows, lowering U.S.
imports of foreign products and dampening foreign gross domestic product (GDP) and
foreign inflation. The second channel, the financial channel, captures the effects of the
rise in U.S. longer-term yields that typically accompanies a tightening of U.S. monetary
policy. Higher U.S. longer-term yields lead international investors to rebalance their
portfolios from foreign to U.S. assets, tightening foreign financial conditions and
3
reducing GDP and inflation in foreign economies. The fact that the bulk of international
transactions are denominated in dollars gives U.S. monetary policy an especially salient
role through the financial channel.
The third channel is the exchange rate channel. A surprise increase in U.S. interest
rates relative to foreign rates usually leads to dollar appreciation. This currency
movement lowers the prices of foreign goods and services relative to those of the U.S.,
thereby restraining U.S. GDP and strengthening foreign GDP. The weaker currency and
the resulting higher activity abroad tend to push up foreign inflation. But for economies
that rely heavily on dollar-denominated debt and have less well-anchored inflation
expectations, exchange rate depreciation can increase balance sheet mismatches and
increase risk premia, with adverse consequences for GDP. So in the end, while
currency depreciation unambiguously raises inflation, its effect on GDP can be
ambiguous for some countries.
All told, the relative strength of the three channels determines the overall sign and
magnitude of the foreign effects of domestic monetary policy tightening. However,
quantifying spillovers is challenging, as the magnitudes (and even the signs) through
the different channels depend on a multitude of structural features of the global
economy.
Moreover, the size of spillover effects also depends on the drivers of the monetary
policy tightening. For instance, when the tightening occurs in the context of high growth,
the positive spillovers of that growth can partially offset the adverse spillovers from the
tightening of financial conditions. The importance of the context in which monetary
policy is changing is increasingly being emphasized in the literature, such as the paper
to be presented in session 4 of this conference. The staff at the Federal Reserve also
have looked at these differences using both event-study and model-based approaches.4
An additional concern, very relevant to the current situation, is what happens when
monetary policy is being tightened simultaneously across a wide set of economies.
When this concurrent tightening happens, cross-border financial spillovers could amplify
5
the effects of our respective tightening. Of course, when others are also tightening,
each respective central bank may need to do a bit less to achieve the same outcomes
because of these spillover effects. But in a world of uncertainty, it is hard to judge the
exact size of these spillovers.
Given the extent of monetary tightening globally over the past two years, it is striking
that emerging market economies have fared relatively well compared with what might
have been expected. A number of factors may be at play. Several emerging market
central banks undertook preemptive rate hikes that helped limit capital outflows,
perhaps avoiding worse outcomes. Effective communication by advanced-economy
central banks may also have prevented greater financial market volatility. In addition, in
these recent stress episodes, commodity prices were rising rather than falling, which
benefited some vulnerable emerging market economies that are commodity exporters.
Of course, many other (commodity-importing) economies did not have such an
advantage. And some emerging market and developing economies, especially those
with high dollar-denominated debt, have struggled amid high commodity prices and
food security issues as well as the resulting global rise in interest rates following the
inflationary shocks from Russia's war against Ukraine.
In sum, U.S. monetary policy actions can produce spillovers abroad and create
tradeoffs for foreign monetary policy. Spillovers from foreign economies can be sizable
for the U.S. as well, especially in the current environment, in which many central banks
have tightened policy rapidly to fight inflation.
In a world of spillovers and global linkages, all of us have our unique responsibilities. At
the Federal Reserve, we are responsible for getting U.S. inflation down to our target.
And in doing so, we are aware that we are affected by and have effects on the world
around us. Conferences like this one help to explore and understand our common
interests and common connections and to spark ideas for addressing the challenges
that confront all of us.
Thank you.
References
Ahmed, Shaghil, Ozge Akinci, and Albert Queralto (2021). "U.S. Monetary Policy
Spillovers to Emerging Markets: Both Shocks and Vulnerabilities Matter," International
Finance Discussion Papers 1321. Washington: Board of Governors of the Federal
Reserve System, July.
Ammer, John, Michiel De Pooter, Christopher Erceg, and Steven Kamin (2016). "
International Spillovers of Monetary Policy," IFDP Notes. Washington: Board of
Governors of the Federal Reserve System, February 8.
Caldara, Dario, Francesco Ferrante, Matteo Iacoviello, Andrea Prestipino, and Albert
Queralto (2023). "The International Spillovers of Synchronous Monetary Tightening,"
paper presented at the 100th Carnegie-Rochester-NYU Conference on Public Policy,
held at the University of Rochester, Rochester, N.Y., April 29.
Curcuru, Stephanie E., Michiel De Pooter, and George Eckerd (2018). "Measuring
Monetary Policy Spillovers between U.S. and German Bond Yields," International
Finance Discussion Papers 1226. Washington: Board of Governors of the Federal
Reserve System, April.
Hoek, Jasper, Steve Kamin, and Emre Yoldas (2022). "Are Higher U.S. Interest Rates
Always Bad News for Emerging Markets?" Journal of International Economics, vol. 137
(July), 103585.
Iacoviello, Matteo, and Gaston Navarro (2019). "Foreign Effects of Higher U.S. Interest
Rates," Journal of International Money and Finance, vol. 95 (July), pp. 232-50.
Rey, Hélène (2013). "Dilemma not Trilemma: The Global Financial Cycle and Monetary
Policy Independence (PDF)," paper presented at "Global Dimensions of Unconventional
Monetary Policy," a symposium sponsored by the Federal Reserve Bank of Kansas
City, held in Jackson Hole, Wyo., August 23.
1
The views expressed here are my own and not necessarily those of my colleagues on
the Federal Open Market Committee.
2
See Ammer and others (2016) for an extended discussion and quantification of these
channels.
3
The financial channel has been documented in recent academic literature, including
Rey (2013) and Iacoviello and Navarro (2019). Estimates of financial spillovers can be
found in Curcuru, De Pooter, and Eckerd (2018).
4
See, for example, Hoek, Kamin, and Yoldas (2022) and Ahmed, Akinci, and Queralto
(2021).
5
See Caldara and others (2023).