The Age of Great Volatility

Since the COVID-19 pandemic broke out, a number of new terms have emerged which reflect the uncertain situation. Restrictions on people’s mobility in the United States to mitigate the COVID-19 pandemic gave rise to the term “the Great Resignation”. The behavior in the workplace is also changing.

Working from home (WFH) with the help of internet technology has now become a necessity that can result in white-collar workers’ resignation, if their needs are not fulfilled. This WFH behavior eventually leads to a saturation point. As a result, family vacations are increasingly needed in order to optimize family welfare (Solberg and Wong; 1992).

The pandemic has increased the use value (marginal unity) of family vacations, due to limited mobility as an impact of the mitigation efforts to prevent the spread of COVID-19. This has caused traffic congestion in a number of airports in the US and Europe during the summer holidays. The number of passengers exceeds the capacity of flights or airport services.

Also read:

> Maximizing Stable Economic Growth

> Economic Recovery Moves on

Along with Maslow's hierarchy (1943), as a result of the economic recovery, the demand for other goods also increases, such as those related to durable goods and processed foods. As a result, world supply chains that have not yet fully recovered are under pressure, resulting in global inflation that spreads to every country.

Central banks in a number of countries have also increased their benchmark interest rates to ease inflation by suppressing a stifled increase in demand, because they cannot control the production or supply side.

Global coordination needed

Obstfeld (2022), a former chief economist of the International Monetary Fund (IMF) and professor of economics at the University of California, Berkeley, US, is of the opinion that due to the lack of coordination, the impact of this one-way policy in raising interest rates will amplify other effects. Therefore, it can become an excessive burden that the world economy cannot withstand.

Among them, the US central bank (The Fed), the European central bank (ECB) and the British central bank (Bank of England).

Obstfeld provides a game theory-style recipe that without having to explicitly coordinate, each central bank can introduce a policy by taking into account the policies (reaction function) of the other central banks that have spillovers or a global fund overflow. Among them, the US central bank (The Fed), the European central bank (ECB) and the British central bank (Bank of England).

In this regard, the World Bank, which is usually very supportive of controlling inflation, in a statement on Sept. 15 warned that the risk of a recession and a global financial crisis in 2023 would be even greater with the lack of coordination in determining benchmark interest rates.

In other words, at the global level, the efforts to reduce inflation should not be too excessive so that the real sector and the financial sector would not fall too deep.

The World Bank has recommended several steps. First, the central bank or monetary authority should communicate their objectives clearly. It seems to be more directed to central banks in developed countries that have a global spillover so that developing countries and emerging markets will have a guideline to take anticipatory steps.

Second, fiscal authorities must exercise caution in normalizing economic stimulus. Fiscal authorities also need to maintain consistency with monetary authorities.

“The great volatility”

In fact, monetary authorities in countries with a large global impact in facing very high uncertainty require out-of-the-box policies. It is important because there is another source of disruption after the pandemic, namely the Russia-Ukraine conflict which has resulted in an increase in prices and volatility of world commodities. Together with the pandemic, this has created a perfect storm, resulting in an era of great volatility.

It also requires a time horizon, when to start and when to end, as it is unlikely to be sustainable in the long term.

With such a situation, policy coordination is no longer a priority because there is a philosophy of "extraordinary times require extraordinary measures". In other words, an out-of-the-box policy is needed in extraordinary circumstances. It also requires a time horizon, when to start and when to end, as it is unlikely to be sustainable in the long term.

Commodity price movements in the last six months have made it very difficult to predict using standard statistical methods. There are too many new variables that have not previously been seen and so the predictions often miss.

A technical analysis for forecasting the future is more effective than conventional statistical tools. This is an implication of future commodity market expectations and the emergency policies of a number of countries.

The latest example is the increase in the Fed's benchmark interest rate by 75 basis points at the end of July. According to Larry Summers, the former US Treasury secretary, it happened because the Fed was too slow. However, high inflation in the US is also caused by a disruption in the world supply chains.

In the context of an emergency, the increase is aimed at quelling global inflation by influencing future expectations in the future commodity market, not just curbing domestic aggregate demand. This is possible because of the position of the US as the world's locomotive and its currency is the world's liquidity. The domestic impact was seen in the fall of US inflation which fell from 9.1 percent in June to 8.5 percent in July and 8.3 percent in August.

However, in its development, inflation in August was still considered not too high. Therefore, an increase of 75 basis points, or even more, remains possible at the end of September.

Public policy implications

The current great volatility is due to out-of-normal action-reaction behavior. Therefore, there is a need to establish a surveillance unit that can observe the world beyond the horizon (beyond the virtual horizon). The behavior of monetary authorities in developed countries and expectations in the future commodity market increasingly require special attention.

Another example, oil prices have fluctuated significantly due to the back-and-forth efforts to revive the nuclear deal between Iran and Western countries.

Many non-economic factors must be considered. For example, the advance and retreat of the soldiers in the Russian-Ukrainian war seems to have begun to affect commodity prices. Another example, oil prices have fluctuated significantly due to the back-and-forth efforts to revive the nuclear deal between Iran and Western countries.

People's behaviors have also changed due to inflation and uncertainty. In accordance with the trend, public policy can be carried out with analytical data that can connect what is visible on the surface (headline watching) and micro behavior. This approach is needed to obtain feedback in the context of adaptive policy design.

KOMPAS/AGUS SUSANTO

Ari Kuncoro

ARI KUNCORO, Rector of the University of Indonesia

(This article was translated by Hendarsyah Tarmizi)