Deniz Kılınç / Istanbul, March 18 (HNA) – Most economists missed the inflation surge and need to understand why and how monetary policy may have to change going forward warned Gita Gopinath, Deputy Managing Director of the International Monetary Fund (IMF), in her recent blog on the IMF publications, stressing that, “Central bankers must learn lessons from past crises.”
“The global inflation surge that abruptly ended decades of moderating price gains came at a unique confluence of crises: the global pandemic and Russia’s invasion of Ukraine,” she wrote and added:
“Now, economists must ask, What lessons does this era offer for monetary policy? We might begin with the lessons from the pandemic and war that are relevant for monetary policy, even if the world eventually moves back to an environment of low-interest rates and low inflation. Most economists missed the inflation surge, and we need to understand why, and how monetary policy may have to change going forward.
“But some crisis effects—high inflation, supply chain disruptions, greater trade barriers—may persist much longer, or intensify. That could challenge macroeconomic stability around the world, especially in emerging markets. How can we avoid this?”
One implication of these insights was that we need better aggregate supply models that reflect the pandemic’s lessons she wrote, “For instance, it will help to further develop sectoral models that differentiate between goods and services and incorporate sectoral capacity constraints to help account for speed effects and nonlinearities at both the sectoral and aggregate levels.”
Running the economy hot seemed to work well for the United States and other advanced economies before the pandemic, while unemployment fell to historic lows, including for disadvantaged workers, while inflation remained below target.
“But inflation risks from running the economy hot may be much greater than we previously thought” Gopinath pointed out, while a key risk is that high inflation de-anchors inflation expectations.
“This would complicate monetary policy trade-offs because currency depreciations and supply shocks would both have much more persistent inflationary effects” she underlined, as bigger interest rate hikes to contain inflation would cause larger output contractions. Especially, significant and front-loaded tightening by several central banks over the past year have helped attenuate de-anchoring risks. Nevertheless, central bankers should remain vigilant.
The challenge for central banks would also be compounded if supply shocks become more entrenched, which may occur if countries decide to reduce the risk of supply chain disruptions by raising trade barriers. That would expose countries to greater supply shock volatility, in turn posing more difficult trade-offs for monetary policy and making economic stabilization harder.
Central banks in emerging markets would be particularly hurt if trade becomes more fragmented and inflation expectations de-anchor, while these economies are already more vulnerable to external shocks, and could face harder policy trade-offs, Gopinath pointed out and went on as follows:
“In principle, the pandemic and war could also have enduring effects on the demand side of the economy by affecting the equilibrium real interest rate (the rate at which in the long run the economy achieves its potential output without incurring inflation). They could impact inequality, demographics, productivity, demand for safe assets, and public investment and debt, among other things. For instance, the pandemic and war may further depress the equilibrium rate by increasing demand for safe assets and raising inequality.
“Overall, these effects probably won’t be particularly large, and, accordingly, the equilibrium rate is likely to remain low—though there remains uncertainty about its actual level. Moreover, a persistent shift to deficit spending, or a sizable catch-up in climate investment, could materially boost the equilibrium rate.”