Deniz Kılınç / Istanbul, March 15 (HNA) – The pandemic and war have bred new challenges for global central banks in coming years, warned Gita Gopinath, Deputy Managing Director of the International Monetary Fund (IMF), in her recent blog on the IMF publications, underlining the “Inflation risks from running the economy hot may be much greater than we previously thought.”
“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 said and added:
“Now, economists must ask what lessons this era offers 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?”
Soaring prices were a surprise from the perspective of pre-crisis policy frameworks, especially for advanced economies, underlined Gopinath, reminding that empirical evidence suggested that inflation rose by only a small amount when unemployment declined, consistent with a very flat Phillips curve:
“This evidence was reinforced by the pre-pandemic experience of inflation that remained tepid even as monetary stimulus pushed unemployment to very low levels.
“However, these models embedding a low Phillips curve slope did a poor job of explaining the pandemic-related surge in prices. Most inflation forecasts based on these models, including ours at the IMF, significantly underpredicted inflation.”
While high inflation partly reflects unusual developments, some forecast errors likely reflect the misunderstanding of the Phillips curve and the supply side of the economy, she pointed out and went on as follows:
“While the standard Phillips curve links inflation to the unemployment gap, the rapid employment recovery may have played a significant role in driving inflation, implying that ‘speed effects’ matter more than previously thought.
“There may also be important nonlinearities in the Phillips curve slope: price and wage pressures from falling unemployment become more acute when the economy is running hot than when it’s below full employment.
“Finally, surging goods inflation during the recovery—when constraints on supply and demand for services meant massive stimulus fell heavily on goods—suggests the importance of capacity constraints at the sectoral, as well as aggregate, level.”