Stock markets are back up! Commodity prices are surging! Retail sales have climbed up impressively in the United States this holiday season! Unemployment claims in US has come down recently to a more than expected level! Hurray! We are back to normal! - is the feeling many are having these days. I hope and wish all these improve further and are sustainable. But when some common people and business persons would start to find some relief from this news, the central bankers, while equally feeling a little relieved, would also be counting in on the hard-work (and for that matter hard-thinking) that they will have to do this year.
Currently, the interest rates are relatively and notably higher in the developing world than the low interest-rate developed world. Capital has been flowing to the developing economies from the developed world throughout last year - only to be fought back by the developing countries to prevent hot money from coming in. But despite this struggle, considerable amount of capital has found its way through to the developing economies, especially into the stock markets. One result of this - a surge in real estate prices (not that foreign money alone was responsible but definitely played a significant part).
When the US economy stabilizes this year, the central bankers in the developing countries would be breaking their head to enact appropriate monetary policies and to prevent any drastic currency volatility since they know that there is a huge possibility for considerable amount of capital, especially from the equity markets, to flow out. At the same time, central bankers in the developed world will be breaking their head to ascertain if the growth that they see in the economy is sustainable. And one of the factors that they will be looking into to assure themselves is the unemployment rate. There has been some kind of fiscal policy support from US government (thanks to some kind of measure done in this regard recently in US - whether what done was right or not is a matter for discussion at some other point in time), that should act favorably for the economy. And moreover, times are different now than what was a decade ago. Even at the setback of the US and European economies, countries like China and India have grown at impressive rates. And as these countries grow, so does the consumption of raw materials by these huge populations. Oil is trading at around $90/barrel, food-inflation is felt all over the world (as per the data released today, UN Food and Agriculture Organization's food price index rose 32% in the second half of year-2010 (not adjusted for inflation), gold prices are surging and so does copper, silver and many other raw materials.
But how much of them are sustainable? Is a commodity bubble in formation? How much inflation and price-rise is attributed to speculators and hoarders? How much is attributed to genuine supply-demand mismatch? With all this and with corruption still having a large presence in the developing world, it is going to be increasingly difficult for central bankers in the developing world to enact monetary policies. And we have to remember that there is always a lag between the time a monetary policy is adopted and when the actual effect is felt in the economy. In the meantime, when deflation was the core concern in US in 2010, 2011's concern is yet to be established - and this will be the concern of US central bankers.
Now what about our European friends?! They will spend time in trying their best to preserve their monetary union and thereby the currency - Euro.With some Euro-zone countries like Germany growing at impressive rates (which will only further grow when US economy stabilizes this year) and some Euro-zone countries adopting fiscal austerity programs due to their heavy indebtedness, it's going to be challenging for Euro-zone central bankers to come up with coordinated policies.
So, with all this, my question of the day - What's going to be the biggest challenge to central bankers in 2011? Answer: Global coordination in adopting policies. If all goes well, we can expect US interest rates to gradually rise around the end of this year, when the developing world around that time might be reducing interest rates to heat up the economy after it finishes cooling as a result of fading of stimulus and monetary tightening during the course of the year. If global macro-economic policies are coordinated, as was done at the wake of the financial crisis, then the policy actions of upward-downward movement of interest rates could be better and smoothly handled without disrupting the growth in the global economy.
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