The efficacy of central banks in confronting the most severe inflation surge in decades has been demonstrated. They implemented measures to maintain the buying power of individuals and businesses. Although there’s still some way to go in restoring price stability, the endpoint is clearly in sight.
Those who least possess the means to cushion against inflation are the ones impacted the most. As the cost of living exhibited a relentless upward trend, it was a necessity for interventions to be implemented. Central banks implemented an unprecedented and coordinated global monetary policy tightening— the largest in decades— with a view to attain price stability.
This has underscored the importance of maintaining independent entities, removed from the political sphere, as the custodians of price stability. This autonomy from governmental bodies enables central banks to execute often politically unpopular, yet necessary, decisions to rein in escalating inflation.
To clarify, favourable conditions helped too. Improved international trade logistics and declining commodity prices gave impetus to disinflation. However, as was evident in the 1970s, if left unchecked, an inflation spike could potentially stimulate a transition to a high-inflation environment.
Central banks, acting within their respective mandates & displaying resolve, have successfully prevented high inflation from becoming the norm. In the absence of swift and decisive action from these banks, achieving price stability could have necessitated a significant sacrifice in terms of growth and employment.
It is crucial not to lower our defences prematurely. Inflation has decelerated yet remains excessively high in some areas. Relative to other prices, both service costs and wages are trailing pre-pandemic trends, and a quick recovery may induce renewed inflationary pressure. The central banks have a responsibility to stay on track.
The recent post-pandemic inflation spike was just the newest challenge to central bank policies. In our most recent yearly economic report, we at the Bank for International Settlements provide an overview of the turbulent time since the start of this century, inclusive of major financial crises and the unparalleled experiment of switching the global economy on and off due to the pandemic.
We contemplate the lessons drawn and their potential impact moving forward. Primarily, our analysis reveals that one crucial learning from the past twenty-five years is the need to discern the limits and potentials of what monetary policy can achieve.
The legacy of a certain historical period truly underlines the impact of monetary policy. It has unraveled the key role central banks can play in ensuring financial and price stability; their swift intervention in times of crisis can hinder a potential economic downturn, ensure a consistent flow of credit to businesses and individuals and maintain the uninterrupted liquidity within the system.
Nonetheless, the premise that central banks can meticulously regulate inflation has proven to be false. It is unquestionably imperative for these financial institutions to take robust action when inflation begins to exceed limits. However, excessive fixation on reaching inflation targets is not always justified, especially when inflation is marginally below these targets, and could even prove to be self-defeating. It’s crucial to view these targets as reference points, rather than compulsive goals.
Apart from this, the economic cost of not taking proactive & decisive steps to restore price stability could potentially be a considerable detriment to growth and employment.
Also noteworthy is the fact that monetary policies, aimed at counteracting unacceptably low inflation, tend to lose their effectiveness if extended for too long. Such extended easing could instigate unwelcome consequences, including all-time high debt levels and distortions in market and investment dynamics. This, in turn, restricts the leeway of central banks to modify their policies and makes the exit from stimulus measures quite challenging, causing entanglement of central bank and government policies.
As different policies deliver the best results when used in cohesion, even with central banks’ ongoing endeavour to keep inflation within limits, it’s noticeable how the fiscal stimuli introduced during the pandemic worldwide may backfire by unwittingly over-stimulating the economy thus fuelling inflation.
Finally, the onus of ensuring a structural increase in economic growth and prosperity is not merely on the central banks. This duty also falls on the shoulders of varied policymakers, particularly the government.
In order to secure benefits over the long haul, it is incumbent upon governments to act swiftly to maintain sound financial practices and future-proof their economies. Capping the growth in public debt and acknowledging that we may not reencounter the exceedingly low pre-pandemic interest rates are some steps in the right direction. Maintaining debt sustainability is intrinsic to ensuring financial and price stability while also stabilising the value of the currency.
In the grand scheme of things, substantial changes are crucial to perpetually elevate the quality of life, enhance economic prosperity and provide a feeling of safety to the public. This entails adopting enduring strategies like endorsing competition, boosting adaptability and inspiring inventiveness. Limited government resources should back the necessary adjustments our economy needs to face new challenges, including climate transformation and the evolution of technology, such as the revolution of artificial intelligence. Only with a robust base can we construct for the imminent future. Agustin Carstens serves as the General Manager at the Bank of International Settlements.