The forces that have held down inflation over the past few decades are stalling or reversing, and central bankers worry that the surge in inflation is gradually evolving become a new and lasting reality, but the report pointed out that if the Fed raises interest rates too much, it may be wrong again.
The annual meeting of global central banks will be held at the Wyoming resort of Jackson Hole from Thursday to Saturday. This is the first physical meeting since 2019. Fed Chairman Powell and other central bank officials will make speeches. speech.
The report cited a March conversation between the Bank of England (BOE) and former Bank of Canada (BOC) governor Mark Carney, reminding investors accustomed to low interest rates to pay attention to changes in central bank practices. “The global economy is going through a series of major shifts. The era of low inflation, low volatility, and easy financial conditions is over,” Carney said at the time.
The report pointed out that the three forces that have depressed inflation over the past few decades are stalling or may be reversed: globalization, labor structure changes, and commodity supply and demand.
The three forces holding down inflation are disappearing
Under globalization, multinational companies can use new technologies to drive down costs and find cheap labor and production locations around the world. Many commodity prices have fallen because of global competition and helped keep U.S. inflation stable. In the 20 years to 2019, the US core consumer price index (CPI) grew at an annual rate of 1.7%.
But after the Covid-19 outbreak and the Russian-Ukrainian war devastated supply chains, many business owners would rather bear higher costs and still try to improve supply chain resilience, such as moving production back to their home countries or sourcing from multiple suppliers. Tensions between Western democracies and China and Russia represent rising protectionism, and production costs are bound to increase.
An ageing population also means that inflation cannot be eased easily. Charles Goodhart, a former BOE official, pointed out in his book “The Great Demographic Reversal” that the low-inflation environment and the weak relationship between monetary policy since the 1990s were mainly due to the emergence of thousands of people from Asia and the Cheap labor in Eastern Europe kept the prices of goods exported to rich countries low.
But now there is no longer a surplus of labor in the world, a shortage of labor will cause inflation to heat up. For example, since the administration of former President Trump, immigration in the United States has gradually decreased. Powell said in an interview in May that the reduction in immigration would lead to a persistent imbalance between supply and demand in the labor market.
Furthermore, energy and commodity players have not invested significantly in new production over the past decade, and in the face of increased global demand, raw materials may face the risk of longer-lasting shortages.
Shifting from a demand shock to a supply shock
When the economy faces a “demand shock,” such as businesses scaling back hiring and investment, consumer spending slumps, and inflation and growth slow in tandem, as was the case with the recessions of 2001 and 2007-2009.
But what came after the outbreak was a “supply shock,” a series of events that affected the economy’s ability to supply goods and services, hit the economy, and increased inflation. The epidemic blockade, the Russian-Ukrainian war and Western financial sanctions have all disrupted supply chains and stimulated demand for commodities, and labor shortages can be seen across the United States.
Faced with a supply shock, central banks must choose between fighting inflation and supporting growth.
Excessive rate hikes bring greater recession risk
30 years of low inflation have allowed consumers and businesses to ignore rising prices, but Fed officials now worry that even if prices are only temporary, consumers and businesses still expect inflation to keep rising, making workers demand higher wages , employers will pass on the increased costs to consumers.
The Fed’s sharp rate hike this year may be the first change in U.S. monetary policy in response to the new environment.But a faster and sharper rate hike would bring greater recession risk and make stocks and longer-dated Treasuries hit more frequently。
The Fed raised rates by 2 yards in May and 3 yards in June and July after raising rates by 1 yards in March.
The report pointed to an important shift between the May and June meetings: Powell and Fed officials saw the need to raise interest rates high enough to slow economic growth.
Fed officials have been remarkably united in the fight against inflation this summer, but if the labor market cools and the economy weakens, Powell’s task of forging an internal consensus could be tougher.
Several former Fed officials who worked closely with Powell have recently warned that Powell may be making the mistake of raising rates too much rather than too little.They argue that Powell may be concerned that over-tolerance of inflation will represent a larger institutional failure.