Once celebrated for their pandemic heroism, the world’s central banks now face a worried crowd


By Howard Schneider, Julie Gordon and Leika Kihara

WASHINGTON (Reuters) – World central bankers, who shared the limelight for sidestepping a pandemic-induced depression with swift action two years ago, are now stumbling through the consequences as they try to quell a surge in inflation that no one predicted or could prevent.

While their response to the pandemic-triggered economic crisis seemed bold and forward-looking, with its long list of new programs and massive monetary stimulus, the past few months have been an erratic, even awkward phase of failed forecasts, embarrassing mea culpas, heightened political scrutiny and some evidence of loss of trust.

Managing inflation is central to a central bank’s mission, and from major players like the US Federal Reserve and the Bank of Japan to regional institutions like the Bank of Canada and the Reserve Bank of Australia, Recent events have dealt a blow to their credibility as they catch up with policies and in doing so increase the likelihood of a recession.

“They had blinkers on. They didn’t want to hear about a stable or upside risk to inflation in response to massive stimulus around the world, government and monetary,” said Derek Holt, head of the Economics of Financial Markets at Scotiabank in Toronto. . “I think they had that evidence even as 2020 unfolded,” but kept emergency programs for another year and viewed an initial rise in inflation as transitory.

Result: in just over a week, the Fed distorted the financial markets with a 75 basis point interest rate hike, its first hike of this magnitude since 1994; the European Central Bank rushed to new contingency plans to control government bond spreads; the Swiss National Bank approved an unexpected rate hike; Bank of England forecasts suggested stagflation was developing; and Bank of Japan Governor Haruhiko Kuroda was forced to apologize after scathing criticism over remarks that households had become “acceptable” of higher prices.

Kuroda’s predicament was emblematic.

Inflation in Japan climbed to just over 2% on an annual basis in April, which is low compared to recent consumer price increases of over 8% in the United States, for example, and effectively met the BOJ’s 2% target after decades of worry about the inverse problem of deflation.

Yet the idea of ​​households accepting higher prices has proven taboo, something central bankers and elected officials around the world are quickly relearning after a generation of prices being held down by various forces, including globalization, which the pandemic may have eroded.

“Each of these central banks have been operating within some sort of risk management framework and really since the financial crisis (2007-2009) … the race was who was going to outperform the other” in order to sustain growth and economic growth. employment in a low and even falling price environment, said Ed Al-Hussainy, senior rates analyst at Columbia Threadneedle. “Now it’s the other way around… The risk of error has moved across the street,” in the form of inflation that threatens to stay higher and take with it public expectations of wages and prices.


Critics say central banks themselves are responsible for keeping interest rates too low for too long and printing too much money for the economy to absorb – especially an economy in which the supply of goods and services has suffered its own setbacks.

Central bankers say much of the current price shock is beyond their control, with inflation made more intense and persistent by events such as the war in Ukraine or China’s still uncertain return to its place in the world. global supply chain of goods.

Whatever the causes, the impact was hard felt by households. Blinded by rising food and energy prices which they believe will be temporary, confidence has begun to erode that central banks will soon hit their typical inflation targets of 2% – a a worrying development that has begun to shape central banks’ own reactions.

After the Fed unveiled its big rate hike on Wednesday, Chairman Jerome Powell was outspoken in linking the historic action to fears the Fed is losing the battle to shape public inflation expectations.

Some economists downplay these expectations, measured in household surveys, as being overly sensitive to things like gasoline and food prices that are excluded from “core” inflation trends. generally considered important in the definition of monetary policy.

But “headline inflation is what people are going through,” Powell said at a news conference after the policy decision. “They don’t know what ‘core’ is. Why would they? They have no reason to. So expectations are very much in jeopardy” the longer headline inflation remains high.

“Central banks have persuaded themselves that longer-term inflation expectations are the main thing”, and have taken comfort in surveys showing that households expect inflation to fall in the coming years, said Karen Dynan, nonresident senior fellow at the Peterson Institute of International Economics and professor at Harvard University. But “people are also looking back, and there’s inertia. They’re thinking about wage and price changes that help them keep up,” and are starting to demand them in ways that drive up prices and prices. wages.

If households are less and less confident, politicians are also taking note.

Bank of Canada Governor Tiff Macklem has faced calls for his impeachment, and the central bank has promised a public review this summer of its flawed inflation forecasts. Australia is planning a review of central bank operations after the Reserve Bank of Australia’s misreading of inflation led it to start raising rates in May after saying until the end of the last year that an increase in borrowing costs was unlikely until 2024.

Powell next week will testify twice before U.S. congressional lawmakers as part of his regular semi-annual monetary policy updates. Sessions will likely focus on the threat of high inflation and what has become the central question as interest rates soar and key markets begin to slow: how bad will it deteriorate ?

Maintaining central bank independence “was easier when central banks were making progress — not when a situation was deteriorating,” said Vincent Reinhart, a former Fed official who is now Dreyfus’ chief economist. and Mellon. He noted that the collective missteps occurred during “the relatively easier part of the tightening period”, when rates have been rising from near zero and the price to pay in terms of slower economic growth and higher unemployment is not yet apparent.

“What happens when you’re closer to the destination…but the destination is much less popular. That’s where they’re headed.”

(Reporting by Howard Schneider; Additional reporting by Julie Gordon, Leika Kihara, Sam Holmes, Balazs Koranyi and Wayne Cole; Editing by Paul Simao)


About Author

Comments are closed.