It will not be much fun being a central banker in 2022. After years of singing from the same hymn sheet on inflation, some central bankers begin to shift their views on how severe a threat inflation is for the global economy.
After years of worrying about the risks of deflation, monetary policymakers once again have to deal with the dangers created by high inflation. The growth prospects of countries that have relied on low interest rates for almost a decade remain weak.
Undoubtedly, the prompt action taken by central banks early in 2020 to keep interest rates low and to buy vast amounts of sovereign debt to manage the impact of COVID on the economies helped preserve financial stability and preserve jobs. Still, the collateral damage partly caused by this loose momentary strategy is the increasingly worrying rise in inflation.
Federal Reserve chairman Jerome Powell and ECB president Christine Lagarde tried to calm markets and politicians that the accelerating rise in inflation was “transitory”.
Lagarde even predicts that by the end of 2022, inflation will start to decline again, while Powell is beginning to prepare the markets for a rise in interest rates in the coming months.
Dissecting the dynamics driving inflation up is crucial to understanding how this phenomenon can be controlled. Inflation would come down with a combination of lower energy prices, more effective supply chains and tighter control of consumer spending. But other factors may not be attracting sufficient attention.
The ageing populations in most western economies create labour shortages, especially in countries that still object to immigration from Third World countries. The shortage of labour in the US and the EU is driving wages higher and there is no indication that this trend will be eliminated soon.
Moreover, geopolitical tensions on Europe’s eastern borders and worsening Sino-US relations are also a cause of uncertainty that instils nervousness in financial and energy markets with frequent spikes in prices.
The IMF is undoubtedly getting worried about the risk of spiralling inflation. In its most recent review of the UK economy, the fund accused the Bank of England interest rate policymakers of allowing inflation to spiral by finding excuses to do nothing.
Central bankers have become experts in using doctored language to not spook markets
The IMF says: “It would be important to avoid inaction bias, in view of costs associated with containing second-round impacts of inflation”.
The Bank of England reacted by raising interest rates − the first major central bank to do so. The Federal Reserve is likely to start raising interest rates in 2022.
The risks of raising interest rates too soon are very real today as the impact of Omicron on most economies remains difficult to predict. The ECB faces the most significant challenges among central banks. While most central banks have already started to withdraw the generous stimulus policies and prepare the markets for tighter monetary controls, the ECB is still scarred by criticism of having raised interest rates too soon after the global financial crisis of 2008.
Some central bankers have become experts in using doctored language to ensure that what they say does not spook financial markets unduly. So what central bank leaders say in their press conferences may not always reflect their well-founded fears.
We need to look elsewhere to understand how and when inflation risks reach a level that requires action to ensure that price rises do not erode families’ income.
Mohamed A. El-Erian, chief economic adviser at Allianz and president of Queen’s College, Cambridge, is a straight talker. He calls a spade a spade when almost everyone else feels inhibited to articulate their fears.
He recently said the Federal Reserve needs to move fast to regain control of the inflation narrative, denouncing chairman Powell’s prior assurance that price increases are short-term. He argues: “the characterisation of inflation as transitory is probably the worst inflation call in the history of the Federal Reserve”.
It would be interesting to know the latest views of El-Eiran and other respected economists on the ECB’s dovish stance on inflation.
Lagarde only recently pledged to “ensure conditions remain favourable” for financing governments, households and firms and described the recent surge in inflation as a “hump” that would decline in 2022.
The sad reality is that the EU, unlike the UK and the US, suffers from financial fragmentation, with 27 different economies facing diverse challenges. This fundamental weakness will persist as long as the EU continues to have a monetary union without a fiscal union or a fully unified banking system.