Why central bankers no longer agree on how to deal with inflation

Once upon a time, central bankers knew what they had to do to deal with inflation. As they grapple with the economic consequences of the coronavirus pandemic, consensus has collapsed on how best to promote low and stable price growth.

After years of setting interest rates on the basis of inflation expectations and pursuing a target of around 2 percent, leading monetary authorities around the world are pursuing different strategies.

Organization for Economic Cooperation and Development Warning this week That “vigilance is required,” but that any attempt to raise interest rates must be “state-dependent and guided by continued improvements in labor markets, signs of persistent inflationary pressures and changes in the fiscal policy stance” — so vague that every major central bank could say its policy meets Standards.

The US Federal Reserve has She changed her position To give more room to inflation and a higher priority to employment, the European Central Bank is embroiled in a row over whether it will be more tolerant of any inflation overshoot, and the Bank of Japan is struggling in vain to revive consumer price growth expectations.

Inflation: a new era?

Prices are rising in many major economies. FT is studying whether inflation is back for good.

Day 1: Advanced economies have not faced a rapid rise in inflation in decades. Is this about to change?

Day 2: The global consensus among central bankers about how best to promote low and stable inflation has collapsed.

Day Three: The Canary in the Coal Mine for American Inflation: Used Cars.

Day four: How the virus could disrupt official inflation statistics.

Day 5: Why high prices in advanced economies are a problem for heavily indebted developing countries.

The shift in US strategy was the most radical. Federal Reserve Chairman Jay Powell announced a new monetary framework last year.

The Fed’s doctrine seeks to walk away from decades of precautionary interest rate increases to fend off potential inflationary pressures while persistently pursuing full employment, a strategy it says will benefit more Americans, including low-wage workers and minority groups.

It would allow inflation to exceed its 2 per cent target for some time after a long-running failure, in an effort to ensure that businesses and firms expect interest rates to remain low for a long time and therefore spend rather than save. One of the Fed’s motivations is to avoid repeating its stance after the financial crisis, when policy tightening slowed the recovery.

“I am alert to the dangers on both sides of this predictable path,” Lyle Brainard said:Fed Governor, on Tuesday. It said it would monitor inflation data carefully to ensure it did not develop in “unwelcome ways” but also “be alert to downside risks too early,” warning against pre-pandemic trends of “low-balanced interest rates”. [and] The lower primary trend of inflation is likely to reassert itself.

But critics worry that the Fed’s strategy was designed for a world of cautious fiscal policy, not an era of pandemic massive borrowing and spending, and that this may leave it behind the curve if price pressures increase.

The annual increase was 3.1 percent on Friday in Basic personal consumption expenditures The index reinforced some of those concerns.

The Bank of Japan has been pursuing a commitment to overshoot inflation for the past five years, but it hasn’t even come close to its 2 percent target. Remarkably, little has changed after the pandemic: Inflation anywhere Looming and spending growth is slow.

Japanese households and companies are convinced that inflation will remain near zero, making it impossible for the Bank of Japan to achieve its target.

“The formation of inflation expectations in Japan is strongly influenced not only by the rate of inflation observed at the time but also by past experiences and standards developed in the process,” Bank of Japan Governor Haruhiko Kuroda said in a recent speech.

Meanwhile, eurozone policymakers are engaging in a angry argument where the European Central Bank conducts a review of its own policy; Results will be announced in September.

Line chart of annual inflation rate (%) showing central banks grappling with price pressures

Olli Rehn, a board member as governor of the Finnish central bank, said recently: “From the point of view of economic and social well-being, it makes sense to accept a certain period of [inflation] Exceeding the limit, considering the date of default in shooting.”

But Isabel Schnabel, the ECB’s executive director, cautioned that it would be risky. Schnabel said last month that although the central bank should not overreact If inflation exceeds After the recession, I became “skeptical” about officially targeting average inflation over a specific period.

“How long should the period be averaged? How much of that should be extrapolated?” she asked. “Personally, I don’t think we should follow such a strategy.”

For some economists, these disagreements are off topic: monetary policy has become so stretched that central bankers lack effective tools to do more.

Richard Barwell, head of macro research at BNP Paribas Asset Management, said the European Central Bank is almost “out of ammunition”, and while eurozone inflation in May rose just above its target of near 2 per cent but below 2 per cent, it He will take an ambitious fiscal policy or simply luck to do it for a long time.

“Unless there is some massive Biden-style fiscal stimulus on the way in Europe or the inflation headwinds abruptly dissipate, the amount of monetary stimulus needed to lift inflation above 2 percent is . . . is beyond what they can do.”

Line chart of central bank policy rates (%) showing interest rates in advanced economies falling to zero

This leaves the Fed alone with a difficult choice in the coming months. Inflation in the United States goal exceeded, the demand is pervasive and he has to decide whether to apply the brakes lightly.

Policymakers are preparing to open a debate ending some of the support, but they have shown no sign of hesitation under their new policy framework, insisting that the recent inflation spike is likely to be temporary rather than sustainable.

Last week, Fed Vice Chairman Randall Quarles said the framework is designed for the current world with “slow labor force growth, lower potential growth, lower core inflation, and therefore lower interest rates.”

“I’m not worried about going back to the seventies,” he said.

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