Analysis: Inflation revival is a victory, not a defeat, for central banks

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FRANKFURT, Oct 13 (Businesshala) – Yes, inflation is back, and if you’re not entirely happy you should probably be in respite.

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It’s a decision by the world’s top central banks, which they hope have hit the sweet spot where healthy economies are seeing a gradual rise in prices – but not growing out of control.

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Backed by heavy government spending, central bankers have used monetary firepower unprecedented in recent years to achieve this result. In fact, anything less would suggest that the biggest experiment in central banking in the modern era had failed.

Only Japan, which has tried and failed to warm prices since the 1990s, remains in a state of inflation.

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For other advanced economies, escalating price pressures have put in sight the elusive goal of removing over-easing policy and ultimately raises the possibility that central banks – prominent during the global financial crisis – will eventually back down. can.

Current inflation growth is certainly not without risk, but comparisons with the 1970s-style stagflation – a period of high inflation and no growth combined with unemployment – ​​appear to be unfounded.

At first glance, the current inflation rates seem really disturbing. Price growth is already over 5% in the United States and could soon reach 4% in the euro area, well above policy targets and at levels not seen well in a decade.

But there is still hard evidence to challenge the narrative of many policymakers that this is mostly a temporary boom caused by the economy’s bumpy post-pandemic.

“The current inflation spike can be compared to a sneeze: the economy’s response to dust in the wake of the pandemic and the ensuing recovery,” said European Central Bank board member Isabel Schnabel.

So if inflation stabilizes at a higher level after the “sneeze”, central banks should be happy, as they have spent most of the past decade trying to raise inflation to lower it.

On-off-record conversations with more than half a dozen central bankers point to relief that price pressures are finally building up and policy normalization, a taboo topic for years, is back on the agenda.

“If inflation doesn’t rise now, it never will,” one policy maker, who spoke on condition of anonymity, said. “These are the perfect conditions, that’s what we did.”

Central banks are already responding. Norway, South Korea and Hungary, among others, have already hiked rates, while the US Federal Reserve and the Bank of England have made it clear that a move is coming.

Even as the ECB, which has lowered its inflation target for a decade, is preparing to roll back the crisis-era measures soon, while markets are now set for late 2022 to early 2023. Interest rate hikes are pricing in, the first such move since 2011.

no ’70s

The likelihood of stagflation appears low given the underlying factors that guide inflation.

Wage growth, a precondition for inflation, remains weak in Europe and below the rate of inflation in the United States. There is no evidence that companies plan to fully compensate workers for one-time price increases.

Labor unions have lost considerable power over the years and wages are now just one component of their demands, with leisure time and job security also on the list. So they are unlikely to wield the bargaining power that pushed wage growth and inflation into double digits in the 1970s.

The impact of skyrocketing energy prices is also likely to be more modest than previously thought. The share of energy in overall expenditure has declined in recent decades and the world has had years of experience managing life with oil prices in excess of $80 a barrel.

“Economies have become far less dependent on energy, both in terms of private consumption and industrial production,” said ING economist Carsten Brzewski. “Any increase in energy prices, as undesirable for producers, consumers and central bankers, does not have the same economic impact as it did in the ’70s.”

In fact, US economic output for every unit of energy has more than doubled since 1975.

In the end, central banks are anything but complacent. Most were given freedom in the 1970s because of inflation, and policymakers are already alert to the dangers of uncontrolled price increases.

“We must remain vigilant, without fever,” French central bank governor Francois Villeroy de Galhau said on Tuesday.

Next Concern – Debt

The headache begins when “temporary” inflation persists for too long and companies begin to adjust both wages and prices, causing a temporary shock to the underlying prices.

“The indicators do not suggest that long-term inflation expectations are dangerously unethical,” said Atlanta Fed President Rafael Bostic. “But contextual pressures can grind to a halt long enough to meet expectations.”

Unfortunately there is no magic formula to determine how long.

In fact, the real concern going forward may be something else: debt.

Governments borrowed large sums of money to tide over the pandemic and easy central bank policy is keeping this debt manageable.

US debt accounts for about 133% of GDP while in the euro area it is around 100%, both up from the mid-70% threshold a decade ago. Japanese debt is more than 250 percent of GDP.

Yet, even as debt levels are rising, their servicing costs have come down in view of the extremely low rates. This means governments are more dependent than ever on central banks, which are near rock-bottom.

Central banks may be forced to choose between living with high inflation or high borrowing costs that thwart growth.

“We are the best friends of finance ministers at the moment, but this is not going to last forever,” said Peter Kazimir, the head of the Slovak Central Bank.

Reporting by Balazs Koranyi; Editing by Toby Chopra


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