The Inflation Fight Could Easily Go Too Far
(Bloomberg Opinion) -- A few months ago, central bankers were on top of the world. It looked like they had pandemic-era monetary policy all figured out. Now formerly confident calls that elevated inflation is a temporary phenomenon are fading to the background, just as the global economy’s strong start to the year is waning.
To curb a rapid rise in prices, the Bank of England is likely to lift borrowing costs as soon as December, a notion once considered far-fetched. The European Central Bank is having trouble convincing investors it will stay true to a pledge to keep rates low. Federal Reserve Chair Jerome Powell probably regrets having ever used the word “transitory,” which he once deployed liberally but now uses sparingly. Powell, whose term ends in February, is also beset by a trading scandal at district Fed banks and attacks on his bank-regulation record. What looked like an easy path to renomination — almost a coronation — has become tougher.
To listen to some of the clamor, you might conclude that raising interest rates as soon as possible would solve the problem. Such a step would be fraught, though, and risks shredding credibility as much as salvaging it.
Most central banks of consequence made clear in the lead-up to the pandemic that inflation was too low. The Fed and ECB undertook high-profile reviews and adopted important changes in how they set the price of money. The Fed moved to an average inflation target, while the ECB said it could live with a bit-above-target price increases, at least temporarily. Transitions like this come along once in a decade, if that. To effectively renounce these shifts so soon wouldn't make inflation disappear overnight and would throw into question any future commitments.
Monetary authorities that have moved quickly to tamp down inflation haven't had an easy time. Poland flubbed communications to the point that economists at one top lender said they would effectively stop listening to what its monetary officials were saying. In Brazil, the central bank sounds determined to crush inflation, almost certainly at the cost of a deep economic slump and the potential enmity of a strongman president running for reelection. The Reserve Bank of New Zealand, enthusiastic about withdrawing stimulus, warned of decades of elevated inflation because of shocks from ruptured supply chains. “We’ve all talked about them, we all knew they were coming, we all said they may be temporary,” RBNZ Governor Adrian Orr said Tuesday. “Now the general discussion is wow, these are persistent. Imagine that continuing now for the next 20-plus years. That is the world that we will be living in.” Is New Zealand prepared to live with high interest rates until mid-century? I’m skeptical.
None of these early responders bear the heavy responsibilities of the Fed, guardian of the world's reserve currency. Big players in monetary policy also need to keep an eye on global growth. The easy part of the recovery is behind us. Early this year, the bullish superlatives on gross domestic product seem to fall from forecasters lips every other week. The International Monetary Fund has called time on that exuberance. Discussions about the best growth in decades are now dotted with references to lost momentum and dangerous unevenness. In China, for decades a source of resilience, growth is slowing. The increase in gross domestic product in the third quarter was 4.9%, almost a full percentage point less than the final three months of 2019, on the eve of the pandemic.
This fragility raises the stakes for the Fed. Aside from being a massive rhetorical climbdown, a reversal would send an ominous signal to policy makers everywhere. “Among the major central banks, the Fed has been one of the most dovish — strongly advocating that the high inflation is transitory and steadfast in achieving its maximum employment goal — so for it to plead a mea culpa would be a powerful signal for its counterparts to also consider changing course,” Rob Subbaraman and Rebecca Wang at Nomura Holdings Inc. wrote in an Oct. 14 note.
Rate hikes aren’t the only solution. The Fed will probably begin tapering its quantitative easing when the Federal Open Market Committee meets next week. That’s a good start. Powell isn’t singularly responsible for unwinding peak stimulus, either — though keeping him in his seat would remove at least one question hanging over the global economy. A lot can still go wrong. It may not be too long before people worry that the biggest threat to the global economy is an abrupt slowdown that might well take inflation down with it.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Previously he was executive editor of Bloomberg News for global economics, and has led teams in Asia, Europe and North America.
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