Opinion: This former central banker says stop fueling inflation with easy money policies

However, both sides agree that at least some of the factors behind the recent rise in inflation will soon abate or disappear. In 2020, prices have only increased slightly and have even fallen in some cases, setting a low base for annual gains in 2021. Heating oil prices skyrocketed.
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and diesel are also often considered temporary. As a result, headline inflation is likely to decline significantly in most countries by 2022.

In the long run, however, we must adapt to higher fossil fuel prices to combat climate change. Likewise, although the widespread spike in prices of building materials, computer chips and raw materials is not expected to continue indefinitely, we are not likely to find a slight decrease either. Castle.

Global conditions change

After all, the problem is global. When China fully entered the world market in the 1990s, the flood of cheap goods put downward pressure on not only prices but also wages. Unions, concerned about job losses, were reluctant to demand higher wages. But for now, these pressures are easing.

It would be a mistake to think that globalization is over, but the reality is that international economic integration has slowed, due to the COVID-19 crisis, the protectionist policies of the Trump administration and the decline China’s labor supply as the population ages. As a result, the global economy is more likely to come under sustained inflationary pressures than in the past.

Arguing that inflation today is temporary assumes that global unemployment remains substantial and unions are weak. In that case, there would be no reason to expect that wages would rise significantly, leading to a sustained increase in prices.

But that may not be true, because the global economy is in turning point: conditions may shift from deflation to more inflation overall. At the national level, wages are being driven by labor shortages in many sectors. For example, the scarcity of truck drivers in the UK has resulted in significantly higher wages. Of course, the recession caused by the pandemic is not comparable to a normal recession, so it remains to be seen how long the wage growth of these industries will spread throughout the economy.

Confidence is the problem

In all cases, monetary policy will determine the course of inflation. In the short term, there is nothing central banks can do to prevent price increases caused by factors such as rising energy costs, nor should they attempt to do so. It is important that the public and financial markets do not lose confidence in the determination of central banks to stabilize inflation (usually around 2%) in the medium term.

So far, the flood of liquid financial markets – especially through the massive buying of bonds – has played a major role in the rise of asset prices.
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The danger now is that this price inflation, combined with an expansion of the money supply, will spill over into consumer prices, which are also affected by a sharp increase in public debt.

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The US Federal Reserve and the European Central Bank (ECB) have always assumed that today’s inflation expectations hold steady at the 2% target and most published inflation expectations for the US and the euro area seems to confirm this view. But the massive bond purchases by these very central banks are distorting market expectations.

Investors with higher inflation expectations tend to sell their bonds to the central bank at what they consider high. As a result, these inflationary pessimists are absent from financial markets, causing the thermometer of inflation expectations to read lower than the actual temperature. In fact, comment increasingly suggested by citizens, consumers and employees in many countries suspect about the stability of inflation expectations at the level required or desired by central banks.

Uncontrolled inflation expectations

With inflation having been out of sight for many years, it is not surprising that expectations are forward-looking, when the dominant expectation of price stability will continue. The credibility of central banks plays a decisive role in supporting that view. But credibility can always be questioned. After a predicted drop in early 2022, what if the inflation rate picks up again and then stays above 2% for a long time? Inflation expectations can become out of control and suddenly increase.

This risk should not be underestimated, especially when the topic of inflation has become prominent everywhere, indicating a clear change in public attitudes. Come explain Former Fed Vice President Alan Blinder, inflation occurs when people start talking about inflation.

In this context, it is important to examine the changes to monetary policy strategy that the Fed and the ECB have made. With the switch to “average inflation target“, the Fed is setting an inflation target above 2% to make up for not having hit that target in the past. However, in a new environment with increasing inflationary pressures, the credibility of the Fed could be severely tested.

Likewise, the ECB signaled by new strategy that it will take a much more relaxed view of inflation above 2% than it has been in the past. Once again, years of established credibility to do whatever it takes to preserve the value of the common currency can now quickly be called into question.

The world is undergoing profound changes. Central banks face a high degree of uncertainty that their traditional models may no longer be reliable. But that’s all the more reason to make sure that they are unquestionably determined to preserve the stability of the currency. Continuing to buy large bonds and a policy that fixes over a longer period through maturities is less relevant than ever.

This commentary has been published with permission of Syndicate Project – High stakes of rising inflation.

Otmar Issing, former chief economist and board member of the European Central Bank, is president of the Center for Financial Studies at Goethe University, Frankfurt.

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