Image: Reuters Berita 24 English - Global central bankers , who made headlines two years ago by averting a pandemic-driven downturn with r...
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| Image: Reuters |
Berita 24 English - Global central bankers, who made headlines two years ago by averting a pandemic-driven downturn with rapid action, are now stumbling through the aftermath, attempting to contain an inflation surge that no one foresaw or was able to prevent.
If their response to the pandemic-induced economic crisis appeared bold and forward-thinking, with a laundry list of new programmes and massive monetary stimulus, the last few months have been an erratic, even awkward period of failed forecasts, embarrassing mea culpas, increased political scrutiny, and some evidence of lost trust.
Inflation management is crucial to a central bank's mandate, and recent events have harmed their credibility as they play catch-up with policy, raising the risk of recession.
"They were wearing horse blinders. They didn't want to hear about inflation being stable or rising as a result of significant government and monetary support around the world "Derek Holt, head of capital markets economics at Scotiabank in Toronto, echoed these sentiments. "I believe they had that evidence even as 2020 unfolded," he said, adding that he kept emergency programmes in place for another year and dismissed an initial uptick in inflation as a blip on the radar.
The result: The Fed whipsawed financial markets with a 75-basis-point interest rate hike, its first since 1994; the European Central Bank scrambled to come up with new emergency plans to control government bond spreads; the Swiss National Bank approved an unexpected rate hike; Bank of England forecasts hinted at developing stagflation; and Bank of Japan Governor Haruhiko Kuroda was forced to apologise after stinging critics.
Kuroda's plight was symbolic of the situation.
Inflation in Japan slowed to slightly over 2% on an annual basis in April, a modest gain compared to recent hikes of more than 8% in consumer prices in the United States, and effectively hitting the BOJ's 2% target after decades of concern over the inverse problem of deflation.
The idea of families tolerating higher prices, on the other hand, proved taboo, as central bankers and elected officials throughout the world are now realising after a generation in which prices were held down by a combination of reasons, including globalisation, that the grip may have crumbled.
"Every one of these central banks is operating in some kind of risk management framework," said Ed Al-Hussainy, a senior rates analyst at Columbia Threadneedle, "and really since the (2007-2009) financial crisis... the race has been who could outease the other" in order to maintain growth and jobs in a low and even falling price environment. "Now that is going backwards... The risk of error has gone to the other side of the street," in the shape of rising inflation, which threatens to erode public wage and pricing expectations.
BLINDSIDED
Critics argue that the central banks are to blame for keeping interest rates too low for too long and printing too much money for the economy to absorb - especially in an economy where the supply of goods and services has been hampered.
Central bankers believe that much of the present price shock is beyond their control, with events like the Ukraine war or China's still-uncertain return to its place in the global commodities supply chain making inflation more acute and persistent.
Whatever the source, the effect on homes has been severe. Faith in central banks' ability to reach their customary 2 percent inflation objectives has begun to erode as a result of rising food and energy prices that were predicted to be temporary. This is a concerning development that has begun to shape central banks' own reactions.
Chair Jerome Powell was forthright when the Fed announced its big rate hike on Wednesday, attributing the historic move to fears that the Fed was losing the struggle to shape public expectations about inflation.
Some economists dismiss such expectations, which are based on household surveys, as being unduly sensitive to variables like gas and food costs, which are not included in the "core" inflation trends that are normally used to decide monetary policy.
"However, headline inflation is what people experience," Powell said after the policy decision at a press conference. "They have no idea what 'core' is. Why would they do that? They don't have any reason to do so. As a result, expectations are in jeopardy "The longer headline inflation remains high, the worse it will be.
Karen Dynan, a nonresident senior fellow at the Peterson Institute of International Economics and a professor at Harvard University, said, "Central banks have persuaded themselves that longer-term inflation expectations were the whole story" and took comfort from surveys showing households expect inflation to fall years in the future. However, "People also look behind, and there is a sense of stagnation. They consider how changes in pay and pricing help businesses keep up with the competition "and start putting pressure on them in ways that will raise prices and wages.
Politicians are taking notice if households are becoming less trusting.
Tiff Macklem, the governor of the Bank of Canada, has received calls for his resignation, and the central bank has pledged a public vetting of their erroneous inflation estimates this summer. Australia is preparing a review of central bank operations after the Reserve Bank of Australia miscalculated inflation and began raising interest rates in May, despite having said until late last year that borrowing costs would not rise until 2024.
Powell will appear twice before members of Congress next week as part of his biannual monetary policy review. The focus of the sessions will most likely be on the possibility of rising inflation and the major question that has emerged as interest rates rise and key markets begin to slow: How terrible is it going to get?
Maintaining central bank independence was "easier when central banks were making headway - not when things were deteriorating," according to Vincent Reinhart, a former Fed official who is currently the senior economist at Dreyfus and Mellon. He pointed out that the collective blunders came during "the relatively easier portion of the tightening cycle," when interest rates are rising from near zero and the cost in terms of slower economic growth and more unemployment is not yet visible.
"What happens when you get closer to your destination... yet it's not as well-known? That's where they're going."
