Back to the 1990s
- US payroll data last week strengthen the Fed’s resolve. The market’s stubborn hopes for a dovish pivot – despite being repeatedly dashed by the dataflow - reflect a refusal to accept a profound shift in policymaking. Rather than the 1970s, we think the 1990s provide the best historical analogies with our current predicament.
Investors’ propensity to hope for an imminent “dovish pivot” – although it was defeated again by robust US payroll data last week - reflects a habituation to the regime of the last 20 years, when central banks could come to the rescue of the real economy and the market, since their primary mission – price stability – was fulfilled irrespective of cyclical conditions thanks to powerful structural forces. Inflation re-emerging put an end to this. We don’t need to return to the Volcker moment of 1980 to define the new policy era. Remembering the 1990s is enough.
Policymakers in the 1990s had to deal with significant supply-side shocks triggered by geopolitical events. They had to cope with insufficient international policy cooperation. While in 1990 the Fed accommodated an adverse supply-side inflation spike, in 1994 it engaged in a rapid tightening to curb excess demand and maintained it despite significant market turmoil. The US is not the only place where central banks were not the “market’s best friend” in the 1990s: under the currency arrangement of the time, most European countries went through the decade with a level of real interest rates far too high relative to their domestic macro conditions.
In Europe, the exit from a series of recessions and financial stability accidents to which inappropriate monetary policy heavily contributed took the form of more integration, with monetary union. This should be a lesson for today, as governments are struggling with defining Euro-wide solutions. Beyond institutional change, at least the 1990s ended up on a positive note, with the promise of favourable supply-side shocks. One, which proved disappointing, was the belief in a significant boost to productivity from the adoption of New Information and Communication Technologies. The other, globalization, proved more lasting and effective. Unfortunately, with mediocre productivity gains for years and deglobalization becoming a major theme, uplifting narratives are currently missing.