Three reasons to believe that a new era of high inflation has begun

Central banks fear a new era of high inflation is dawning (Otto Dettmer/The Economist)

In August 2020, Jerome Powellpresident of the Federal Reservedescribed a change in the central bank’s policy framework. “The economy is always evolving“, he pointed. “Our revised statement reflects our appreciation… that a robust labor market can be sustained without causing an unwanted rise in inflation.”. This is a change of course based on a long period in which prices have risen less than the Federal Reserve preferred and more.

Two years later, the Federal Reserve it faces very different circumstances: minimal unemployment, strong wage growth and inflation rates well above the central bank’s target. On August 26, at an annual meeting of central bankers in jackson hole, Wyoming, Powell sang a different song. “Without price stability, the economy does not work for anyone”, he declared, adding that the Federal Reserve it was prepared to impose economic pain to get inflation back on target. It is not known how much will be needed. But the economists and policy makers gathered under the mountains teton repeatedly expressed grave concern: that the global forces that have helped keep inflation low and stable in recent decades may be weakening, or reversing.

Misquoting the Milton Friedmaninflation is often and above all a monetary phenomenon. Central banks have many tools at their disposal to limit spending throughout the economy and thus prevent demand from outstripping supply in a way that feeds inflation. But they do their job in a changing economic environment, which can make managing price pressures easier at times than others. Beginning in the 1980s, inflation in the rich world fell overall and became less volatile. The phenomenon is commonly attributed to better monetary politicsbut also to more benign global conditions than those central banks had to contend with in the 1960s and 1970s – namely high-spending governments and energy crises – when economies were hit by falling productivity growth . The world may now be “on the cusp of historic change,” as he put it in Jackson Hole. Augustine Carstensof Bank for International Settlementsa club of central banks.

Those concerned see some reasons why inflation may remain high. First, public spending and borrowing patterns seem to have changed. In rich and emerging economies, the burden of public debt has skyrocketed in the last two decades. As debt burdens mount, markets may start to fear that central banks will have to help finance government obligations, for example by creating new money to buy bonds. This could erode the credibility of central banks and increase the public’s inflation expectations.

The fiscal power deployed during the pandemic of the COVID-19 it may also reflect a greater openness of governments to using stimulus to fight the recession, which could also lead markets to expect more spending and inflation. Papers presented at the conference by Francesco Bianchiof Johns Hopkins UniversityY Leonardo Melosiof Federal Reserve Bank of Chicagosuggest that US inflation was about four percentage points higher than it would have been under other circumstances, thanks to “fiscal inflation” associated with the $1.9 trillion stimulus package approved in 2021.

Workers are also scarcer. Population growth in the rich world has slowed dramatically due to demographic change and less immigration. In some economies, such as the United States, the pandemic was associated with a further decline in labor force participation. From the 1990s to the 2010s, the global labor supply expanded rapidly as populous economies like Porcelain me India better integrated into the world economy. But that experience cannot be repeated, and aging is beginning to affect labor supply in parts of the emerging world as well. Workers may therefore enjoy greater bargaining power in the future, spurring wage growth and making life more difficult for inflation-fighting central banks.

On the other hand, slow changes are taking place in the structure of the world economy. Both emerging and advanced economies undertook a wave of liberalizing reforms from the mid-1980s to the mid-2000s. Tariffs were lowered, while labor and product markets became more agile. These reforms contributed to an increase in world trade, to large-scale changes in world production, and to falling costs in a whole series of industries. The reforms may also have boosted productivity growth, which rose in advanced economies at the turn of the millennium and in emerging economies in the 2000s.. But the pace of reforms slowed and productivity growth slowed in the aftermath of the 2007-09 global financial crisis, while trade came under constant pressure from trade wars, the pandemic and geopolitical tensions. Globalization served asgigantic damper”, from the 1980s to the 2010s, noted Elizabeth Schnabelof European Central Bankso that changes in demand or supply were easily resolved by corresponding adjustments in production, rather than wild swings in prices. Now that flexibility is in jeopardy.

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For the central bankers who attended the meeting, this was very encouraging. But it doesn’t have to be apocalyptic. Some trends could make the new macroeconomic era a little easier to bear. Demographic change can be two-sided, as noted Gita Gopinathof IM F. Although workers in aging economies may be in short supply, they will also save more, helping to mitigate inflationary pressures. And, as was said at the symposium, the changes brought about by the pandemic can produce a productivity dividend.

The most important thing is that today there is less intellectual confusion than in the 1970s.. As pointed out by Mr. Powellcentral bankers once needed to be convinced that they could and should take responsibility for the level of inflation, a situation that allowed high inflation to rage for more than a decade. Today, on the contrary, theThe Federal Reserve’s responsibility to provide price stability is unconditional.”. Central bankers are beginning to accept that their task may be more difficult in the years to come. That awareness could itself prevent a new era of shocks and volatility from being truly disastrous.

© 2022, The Economist Newspaper Limited. All rights reserved.

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