The multi-speed recovery of the global economy is prompting a kaleidoscope of policy responses from central banks around the world, muddying the outlook for investors and heightening the risk of market volatility.
One size never fits all. Emerging market central banks in particular have deployed an array of measures, from taxing capital inflows to penalising property speculators, in order to limit inflationary risks when the world is awash in liquidity.
What has been striking in the past week, however, has been the pronounced divergence in the rhetoric of three of the biggest central banks from the developed world.
While the Federal Reserve exuded confidence that ultra-loose U.S. monetary policy was still appropriate, European Central Bank President Jean-Claude Trichet took a hard line and said core prices excluding food and energy were not necessarily a good pointer to future headline inflation.
Two days later, Bank of England Governor Mervyn King all but contradicted Trichet's reasoning. King acknowledged that headline inflation in Britain was heading for 5 percent but said the BoE had been right not to raise interest rates yet.
That was because the increase in inflation had been due to a combination of one-off pressures from import prices, dearer oil and higher indirect taxes, King explained.
What is going on? Have central banks lost their monetary compass? After impressive cooperation in 2008 after the collapse of U.S. investment bank Lehman Brothers, have they lost the will to coordinate?
For now, central-bank watchers are not too concerned.
"I wouldn't call it disunity," Peter Westaway, chief European economist for Nomura, said during a visit to Beijing. "It's interesting but I don't think it's a massively destabilising feature."
DIFFERENT MANDATES
The Fed is dovish because, with the U.S. jobless rate at 9.4 percent, the central bank is failing to fulfil part of its dual mandate — to maximise employment and to keep inflation down.
For its part, the ECB is turning hawkish because inflation is above its prescribed target of below, but close to, 2.0 percent.
"I wouldn't say there's any disarray. There's always a range of views," agreed Michael Dicks, chief economist at Barclays Wealth in London.
"There's a more hawkish skew in Europe," Dicks said. "We tend put more weight on core inflation here in the UK because it has a better track record than it does in Europe."
Nonetheless, the longer that emerging markets sustain strong growth, the greater will be the need for Western central banks to re-examine some of their hallowed policy assumptions.
If China and India keep growing at near 10 percent a year, driving up demand for oil, copper and other raw materials, can a spike in the price of such commodities always be brushed off as temporary?
If scores of millions of people every year are pulled out of poverty and can afford higher-protein diets, can every jump in corn and wheat prices be excused as a passing supply shock?
If emerging markets' exchange rates rise in tandem with their living standards, can increases in the cost of the goods they export to the West always be dismissed as a one-time adjustment?
(It is worth remembering that the avowed political objective of the United States and Europe is to get China to increase the cost of its exports.)
In the event that these shifts are indeed structural, the consequences for Western economies and central banks could be profound, as ECB policymaker Lorenzo Bini Smaghi acknowledged on Thursday.
Speaking in Bologna, Bini Smaghi said prices of goods from Asia and other emerging economies were indeed likely to rise more quickly in future than in the past decade.
As a result, domestic prices would have to rise at a slower pace to keep inflation in line with the central bank's target.
"To avoid the second-round effects, it is necessary for the dynamics of costs and prices in advanced countries, including those in the euro area, to be significantly more contained than those of emerging countries," he said.
NEW GAME, NEW RULES
History points to the potential perils in coordinating policy when the world economy is going through profound rebalancing as it is now.
Back in 1987, semi-public squabbling between Germany and the United States over interest rates rattled confidence and was a factor behind the Black Monday stock market crash in October of that year.
Policy tensions are nowhere near as acute today, except, perhaps, over the stance of the People's Bank of China.
Fears voiced by Brazilian Finance Minister Guido Mantega that policy clashes could trigger currency and trade wars have not come to pass.
"For the moment the tension has not resulted in damaging trade and opening a new front — for the moment," Pascal Lamy, director-general of the World Trade Organization, told reporters at the World Economic Forum in Davos.
But Andrew Milligan, head of global strategy for Standard Life Investments in Edinburgh, said investors had reason to be worried about the divergence in economic pressures and policies — not only between emerging and developed countries but also within regions, the prime example being the euro zone.
"At the very least that means investors need to take into account different currency trends or bond market yield curves in their investment considerations," Milligan said.
"To the extent that many investors in the U.S. and Europe have priced in high rates of economic growth in Asia, and central banks there are starting to be more aggressive, then we can see market volatility," he added.
Given that the world economy has still not recovered from the deepest financial crisis in 80 years, it is not surprising that policymaking is in flux and that unorthodoxy is in fashion.
Think of the Fed's controversial $600 billion "QE2" asset-purchase programme. Or fast-growing Turkey's eyebrow-raising combination of interest rate cuts and higher bank reserve requirements to staunch capital inflows while mopping up liquidity.
"Turkey has shown that just as the West can develop unconventional policies, so can emerging market countries," David Bloom and fellow HSBC currency strategists said in a report.
"New rules are being written as we speak," they said.
