Analysis-The rebound in inflation is a victory, not a defeat, for central banks



By Balazs Koranyi

FRANKFURT (Reuters) – Yes, inflation is back, and you should probably be relieved if not downright happy.

That’s the verdict of the world’s largest central banks, which hope they’ve reached the sweet spot where healthy economies see prices slowly rising – but not spiraling out of control.

Supported by vast government spending, central bankers have unleashed unprecedented monetary firepower in recent years to achieve this result. Indeed, nothing less would suggest that the greatest central banking experiment of the modern era had failed.

Only Japan, which has tried and failed to raise prices since the 1990s, remains in the doldrums of inflation.

For other advanced economies, an increase in price pressures puts the elusive goal of unwinding an ultra-easy policy into perspective and finally raises the prospect that central banks – put forward during the global financial crisis – could finally. to move back.

The current rise in inflation is not without risk, of course, but comparisons to 1970s-style stagflation – a period of high inflation and unemployment combined with little or no growth – seem unfounded.

At first glance, current inflation rates do indeed seem worrying. Price growth is already above 5% in the United States and could soon reach 4% in the eurozone, well above political targets and at levels not seen in more than a decade.

But hard evidence has yet to challenge the narrative by many policymakers that this is mainly a temporary surge caused by the bumpy reopening of the economy after the pandemic.

“The current inflationary spike can be compared to a sneeze: the economy’s reaction to the dust raised in the wake of the pandemic and the recovery that follows,” said Isabel Schnabel, member of the board of directors of the European Central Bank.

So if post-“sneeze” inflation sets in to higher levels, central banks should be happy given that they have spent most of the last decade trying to increase, not increase. reduce inflation.

Recorded and unofficial conversations with more than half a dozen central bankers show that price pressures are finally escalating and that policy standardization, a taboo subject for years, is back on the agenda. .

“If inflation doesn’t go up now, it never will,” said one politician, who asked to remain anonymous. “These are the perfect conditions, that’s what we worked for.”

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

Even the ECB, which has not reached its inflation target for a decade, is preparing to cancel measures taken during the crisis in the near future as the markets now count on an interest rate hike in late 2022-early 2023, the first of its kind since 2011.


Stagflation seems unlikely given the underlying factors driving inflation.

Wage increases, a sine qua non of inflation, remain anemic in Europe and remain below the rate of inflation in the United States. There is no indication that companies plan to fully compensate workers for one-off price increases.

Unions have lost considerable power over the years and wages are only a component of their demands, with leisure and job security also on the list. They are therefore unlikely to wield the bargaining power that drove wage growth and double-digit inflation in the 1970s.

The impact of soaring energy prices is also expected to be more modest than in the past. Energy’s share of overall spending has fallen over the past few decades, and the world has years of experience managing life with oil prices above $ 80 a barrel.

“Economies have become much less dependent on energy, both in terms of private consumption and industrial production,” said ING economist Carsten Brzeski. “Any increase in energy prices, no matter how unwelcome for producers, consumers and central bankers, does not have the same economic impact as in the 1970s.”

Indeed, US economic output for each unit of energy has more than doubled since 1975.

Finally, central banks are anything but complacent. Most gained independence precisely because of the inflation of the 1970s, and policymakers are already aware of the dangers of uncontrolled price increases.

“We must be vigilant without being feverish,” French central bank governor François Villeroy de Galhau said on Tuesday.


The puzzle begins when “temporary” inflation persists for too long and firms begin to adjust both wages and prices, entrenching a temporary shock in underlying prices.

“The indicators do not suggest that long-term inflation expectations are dangerously disconnected,” said Atlanta Fed Chairman Rafael Bostic. “But the episodic pressures could last long enough to lower expectations.”

Unfortunately, there is no magic formula for determining how long is too long.

In fact, the real worry for the future might be something else: debt.

Governments have borrowed huge sums to get out of the pandemic and the easy going policy of the central bank keeps this debt manageable.

US debt represents around 133% of gross domestic product, while in the euro area the level is around 100%, both up from 70% of just over a decade ago. Japanese debt exceeds 250% of GDP.

Yet even as debt levels rise, the cost of their service has come down given the ultra-low rates. This means that governments are more dependent than ever on central banks which keep rates near the lowest.

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

“At the moment we are finance ministers’ best friends, but this is not going to last forever,” said Slovak central bank chief Peter Kazimir.

(Reporting by Balazs Koranyi; Editing by Toby Chopra)



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