Central banking has a forbidding future

Bears, bulls, hawks, doves: each animal in the macroeconomic menagerie can be found between the peaks, prairies and ranches of Jackson Hole, Wyoming. During the Kansas City Federal Reserve’s annual central-banker bash on August 27th-29th your columnist spotted a black bear and learned the rudiments of cattle-roping. (The trick to roping a bull, it turns out, is knowing when to let go.) But it was a hawk that was the talk of the town.

Kevin Warsh, the new-ish Fed chair, arrived in the Grand Tetons after a frustrating start. Markets had been baffled by his gnomic, occasionally contradictory press conferences. Worries lingered that he lacked the backbone to defy Donald Trump. A week earlier Scott Bessent, the treasury secretary, had meddled in America’s bond market, which smelled like pre-midterm politicking. Despite those efforts, yields continued to surge.

Fortunately for Mr Warsh, the upside of low expectations is that they are easier to surpass. By that standard, the hawk soared. After reiterating his dislike of explaining himself to markets, Mr Warsh did just that. He walked through inflation (troubling) and unemployment (not so): the sort of “reaction function” he’d disavowed, and a hawkish one, too. He emphasised the Fed’s main inflation gauge over funky alternatives. Insiders saw the clawprints of career staffers. The hawkish talk half-worked. That day markets shortened the odds of a rate hike but, reassuringly, without a further rise in long-term yields. Still, tough talk can only do so much: yields resumed their upward march the following week.

Has Mr Warsh now backed himself into a corner? The crowd at Jackson Hole was split. One side reckoned that after such a firm steer he has no choice but to raise interest rates. If not, questions about his seriousness and political independence would deepen. Others noted that even a pre-Warsh Fed would be cautious about big moves so close to an election. And besides, raising rates in September versus December makes little economic difference. Markets now put the odds of a September hike at a little over half.

Whatever leeway Mr Warsh bought himself came from going back to central-banking basics. But the official theme of Jackson Hole was on the future: “Financial Innovation: Implications for Payments and Policy”. Panellists debated whether stablecoins and tokenised deposits might revolutionise financial plumbing. Darrell Duffie of Stanford University suggested that programmable money may better co-ordinate complex multi-step transactions. Perhaps it could smooth cross-border payments. Wenxin Du of Harvard Business School countered that conventional financial technology could do the same, often more simply and cheaply.

Ken Rogoff, also of Harvard, spoke for many when he decided to ignore stablecoins (a dry topic, even by central-banking standards) and focus on bond yields and debt. Channelling Alexandria Ocasio-Cortez, a leftie standard-bearer who recently described the social-justice frenzy of “woke 1.0” in the early 2020s as “crazy”, Mr Rogoff denounced “macro woke 1.0”: arguments from the same era that interest rates would stay low, justifying more public borrowing. He added swipes at old adversaries: “I wish I was as sure of anything as Paul Krugman is about everything.”

Now interest rates are up and public debt is higher than ever: a woeful combination, especially for central bankers. One risk is that government bonds stop behaving like a safe asset. Eswar Prasad of Cornell University presented a paper noting that the “convenience yield” investors are willing to forgo for safety has vanished. Still, he found, the dollar’s position remains strong and financial innovations like stablecoins may bolster that dominance.

Any boost for American assets from stablecoin demand would be dwarfed by a second risk of high borrowing: that debt pushes politicians to meddle with central banks. Mr Rogoff framed the worry around Elizabeth Warren, another leftie icon (whose leftier advisers “make her look like Ronald Reagan”). But the problem is structural. When debts are high, co-opting central banks into financing the government can become appealing. Left unsaid was that greater risks today, as Mr Bessent’s moves show, come from the opposite side of politics to Ms Warren.

A different beast

If “macro woke 1.0” is buried, what about “macro woke 2.0”? That, Mr Rogoff suggested, might be the hope that artificial intelligence solves economic woes. Mr Warsh was as AI-woke as anyone while vying to become Fed chair; in his speech in Wyoming, less so. His remarks on AI were framed mainly as questions, and he hinted that the initial effect of the technology would probably be to raise inflation by supercharging data-centre investment.

AI poses more direct risks, too. Markus Brunnermeier of Princeton presented a paper arguing that markets may be hit early by advanced AI, endangering financial stability. Robot traders have “asymmetric understanding”, he argued: they get humans perfectly but are themselves perfectly inscrutable. That observation led Mr Brunnermeier to some radical ideas: human-only markets off limits to AI, and randomised central-bank decisions that AIs have no edge in predicting. Those conclusions were controversial. Raghuram Rajan of the University of Chicago observed that markets are already full of humans with conflicting, often opaque motivations; AI may itself help humans understand AI. As for markets, they are already a bit of an alien superintelligence.

Next year will be the Jackson Hole pow-wow’s 50th birthday. The Tetons will still be full of bears and hawks. Many of the human faces will be the same, too: central banking is not exactly a field with a high staff turnover. Debt problems and AI risks will also persist, and probably mount. If Mr Warsh keeps up his new regular-central-banker act, he may at least have built more credibility to find a mountain path through them. ■