Inflation Is Posing 19 Problems for One Central Bank


SINTRA, Portugal — For central bankers, the world has changed abruptly. After more than a decade of low inflation and interest rates, policymakers are now in an environment of high inflation, where there isn’t time for ponderous decisions, only swift and decisive action.

This was the verdict among policymakers and economists who gathered in a luxury golf resort northwest of Lisbon this week for the European Central Bank’s annual forum.

Since 2014, this annual meeting in Sintra has been preoccupied by one major goal: how to stoke inflation in the eurozone.

Not this year. Amid vast global supply chain disruptions, a war in Ukraine and soaring energy prices, policymakers are confronting the opposite challenge. Inflation is the highest it has been in decades. On Friday, data showed the annual rate of inflation in the eurozone climbed to 8.6 percent in June, yet another record.

But while the outlook for price growth has many variables outside the central bank’s control — such as the length of the war and the future of energy supply from Russia and elsewhere — the message to central bank officials was clear: The buck stops with you.

Looming over the panel discussions and presentations were memories of past crises, including the 1970s era of global stagflation and the euro sovereign debt crisis about a decade ago. Like many other advanced economies, Europe is trying to steer clear of the trap of stagflation — a period of stagnant economic growth and uncomfortably high inflation — but it is also attempting to raise interest rates without setting off panic in government bond markets about the finances of the region’s more indebted countries.

“Monetary policy is at a difficult juncture,” Christine Lagarde, the president of the E.C.B., said at the forum’s opening on Monday, a statement no one in the room disagreed with.

Over the next two days, she reiterated the central bank’s plan to raise interest rates for the first time in more than a decade in July by a quarter percentage point, and again in September with an increase that’s likely to be even larger. Rates are expected to keep rising from there, in keeping with a principle of “gradualism.”

The risk of persistently high inflation outweighed concerns that the region’s economy was slowing down. There might not be a return to the world of low inflation that has dominated for the past few decades, Ms. Lagarde said. Inflationary forces had been “unleashed” by the Covid-19 pandemic and war in Ukraine, she added.

After a two-year hiatus from meeting in person because of the pandemic, the collegial mood was run through with the somber message of the severity of the challenge central bankers faced.

Despite growing mountains of economic, business and financial markets data, working out where people think inflation is going to go is still, to some extent, like reading tea leaves. One panel discussed how hard it was to know whose inflation expectations were the most useful for predicting inflation — households’, businesses’ or financial markets’. And how there was still no precise way to know if long-term expectations have risen above the central bank’s target, a dangerous situation that would perpetuate high inflation.

But policymakers can’t risk waiting to find out, Loretta J. Mester, the president of the Federal Reserve Bank of Cleveland, told the audience. “Central banks are going to need to be resolute and they are going to be intentional in taking actions to bring inflation down,” she added.

And these actions might be painful for people, warned Jerome H. Powell, the chair of the Federal Reserve, a conclusion Ms. Lagarde agreed with. But, he said, it would be more painful to let high inflation become persistent.

The E.C.B. is only just starting to raise interest rates, months behind its American counterpart. High inflation is a worldwide problem, but for a while the difference in the sources of price increases allowed the E.C.B. to take a slower approach. High energy prices and global supply chain disruptions aren’t phenomena the bank can stop by raising interest rates. Unlike the Fed, European policymakers are not trying to cool down an overheating economy. In Europe, consumption hasn’t even recovered to its prepandemic levels.

As inflation surged higher and the bank’s own economists starting publishing starker forecasts, the risk grew that fast price growth would become entrenched. After a few months of division on the governing council, when a handful of rate-setters pushed for faster action, a sense of unanimity is slowly emerging.

“With hindsight, I think many governing council members would have liked to hike rates already in June,” said Frederik Ducrozet, the head of macroeconomic research at Pictet Wealth Management. “But it’s a very difficult situation because you know that we are heading into a slowdown.”

However, at the moment, “inflation concerns trump everything else,” he added.

What makes today different from the 1970s is that central bankers can act more aggressively and are more active, said Hilde C. Bjornland, an economics professor at BI Norwegian Business School, in a presentation of the recent increase in oil prices and how that weighs on the European economy and affects inflation expectations.

“That requires swift action from the central bank, and it requires this swift action now,” she said.

What hasn’t changed for the central bank since its founding is that it is still holding together a monetary union — the eurozone — without the supporting infrastructure of a fiscal union, banking union or capital markets union.

It has to supply one policy for 19 economies. In June, inflation ranged from 6.1 percent in Malta to 22 percent in Estonia.

“That is one of the issues for the euro area and the European Union to tackle,” said Martins Kazaks, the governor of the central bank in Latvia, where inflation has hit 19 percent. “The institutional architecture of the euro area and European Union is by no means complete.” Fiscal policy needs to step in and provide support for the most vulnerable, but it has to be targeted and time-limited, unlike pandemic support programs, he added.

“In the current situation, when inflation is so high, monetary policy will need to tackle the problem of inflation,” he said. “We will not go the same way as fiscal policy.” He has suggested that the rate increase in July might need to be larger than the quarter point currently telegraphed. Gradualism “doesn’t mean slow,” Mr. Kazaks said.

While the E.C.B. fights this inflation problem, it has to ward off another crisis — the risk that rising interest rates and the end of the massive bond-buying programs cause the borrowing costs of the financially weaker economies to spiral higher. In mid-June, the yield on Italy’s 10-year government debt jumped above 4 percent for the first time since 2014, and the gap over Germany’s borrowing costs, the region’s benchmark, was the widest since early 2020 when the pandemic roiled financial markets.

In response to the growing disparities in borrowing costs, the central bank announced that it would use the reinvestments from bonds maturing in its 1.85 trillion-euro ($1.9 trillion) pandemic-era bond-buying program to buy other bonds to help ward off so-called market fragmentation that could disrupt the effectiveness of its monetary policy. The bank also said it would accelerate the design of a new policy tool to address that problem, according to Ms. Lagarde.

Any new tool has to be alert to legal and political challenges it might face. A decade ago the central bank tried to design a policy tool that would match the commitment by Mario Draghi, the former president of the central bank, to do “whatever it takes” to save the euro.

The result of the effort was a program to allow the central bank to buy an unlimited amount of debt on the market issued by distressed countries provided they were part of a formal bailout program, where a separate body enforced economic reforms. The initiative was met with legal challenges and political fights — but, in the end, the announcement of this tool was enough to help calm investors in the bond market.

It has never been used.

The volatility in the bond market today is less severe, so the new tool isn’t expected to come with such strict conditions. But the bank will have to carefully design a tool to avoid sending a confusing message of tightening monetary policy with one hand but easing monetary policy with the other.

But this challenge won’t stand in the way of what Ms. Lagarde is now presenting as a cleareyed and single-focused vision on tackling inflation.

“We will address every obstacle that may pose a threat to our price stability mandate,” she said. “We will.”



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