At the recent central banker conclave in Jackson Hole, Wyoming, the two most powerful central bankers in the world, Janet Yellen, chair of the U.S. Federal Reserve, and Mario Draghi, president of the European Central Bank (ECB), gave back-to-back addresses on the same subject.
It was like a controlled experiment in the attitudes and capabilities of the two leading financial powers in the world.
The contrast could not have been more striking. Draghi was nuanced, technically proficient, and had some excellent policy suggestions. Yellen was rigid, backward-looking, simplistic, and made disastrous policy prescriptions.
A close examination of the two speeches is a master class in the current state of central banking and a window into a distressing economic situation facing the world today…
This Debate Is Really About Central Bank Intervention
The topic they both addressed is arguably the most important policy issue facing central banks and governments today. Draghi and Yellen considered the extent to which unemployment is cyclical or structural. If unemployment is cyclical, it means that it is due to temporary factors that monetary policy can help to correct. If it is structural, it means that unemployment is due to deeper, more permanent factors that only structural policy changes can ameliorate.
Structural changes involve things such as tax, regulatory, healthcare, environmental, and other policies usually handled by legislatures. Since central banks cannot make structural changes, it means that monetary policy cannot solve the unemployment problem.
The debate over the cyclical versus structural causes of unemployment is really a debate over whether central banks can help or not.
Unemployment is the major economic problem facing advanced economies today. Five years after the end of the severe recession that struck the world in the wake of the 2008 panic, economic growth in Europe and the United States is not only sluggish, but occasionally negative.
In parts of Europe, growth has already dipped into recession. Tepid growth has not been enough to undo the damage of the last recession let alone absorb new entrants into the workforce or absorb vast numbers of unemployed youth and minorities. All economists agree that both cyclical and structural factors are at work.
The question is what is the mix of the two? Is the problem predominately cyclical or structural? Economists do not agree on the answer, and have produced varying estimates and research reports. This is the most important debate in economics today.
Draghi's Actions Speak Louder Than Yellen's Words
Draghi said that monetary policy can help prevent deflation, and that he was prepared to use unconventional monetary tools such as negative interest rates and quantitative easing to fight it. But he said that unemployment is largely a structural problem and it was up to the governments of the Eurozone and the EU itself to solve that problem through unified bank regulation, coordinated fiscal policies, improved labor mobility, and other policies not controlled by central banks.
Draghi also showed a good grasp of complexity theory and was properly wary of some of the unintended consequences of overly loose monetary policy. He was concerned about asset bubbles and inflation risks if monetary policy was too loose for too long.
In short, he acknowledged some role for the ECB, but was concerned about bubbles. He put the need for action squarely on the shoulders of the governments of the Eurozone members.
Draghi once again demonstrated that he is a master of the art of central banking, which involves saying little and doing less. He says what needs to be said to reassure markets at key junctures, and then says little else. He does not act at all if words alone are enough. This is the gift of great central bankers. Draghi seems to be the only central banker left who still possesses the gift.
Yellen's speech was the opposite.