SINTRA, Portugal — Three of the world’s top central bankers on Wednesday made a stark prediction: The forces that held inflation down for decades before the pandemic broke out may never return, forcing policymakers to press ahead with efforts to to cool economies in a bid to control rapid price increases.
“Since the pandemic, we live in a world where the economy is driven by very different forces,” Federal Reserve chairman Jerome H. Powell said Wednesday in a panel alongside the heads of the European Central Bank and the Bank of England in Sintra, Portugal. In the past, forces like young demographics and globalization helped keep production cheap and price increases slow.
“What we don’t know is whether we’re going back to something that’s more like, or a bit like, what we had before,” said Mr. powell. “We suspect it will be some kind of blend.”
Christine Lagarde, Mr Powell’s counterpart in Europe, gave an even more blunt assessment, saying the era of low inflation that predated 2020 is unlikely to return.
“There are forces that have been unleashed as a result of the pandemic, as a result of this massive geopolitical shock that we are now facing, that will change the image and the landscape in which we operate,” said Ms Lagarde. , referring to the war in Ukraine, which has caused raw material prices to rise sharply.
Andrew Bailey, the governor of the Bank of England, agreed that this was another period of price increases against which policymakers should pull back.
Their comments underlined the challenge central bankers face as inflation rises in many advanced economies. Part of the recent increase is due to strong domestic demand in countries, including the United States, where apartment rents are soaring, hotel room prices are much higher and a variety of services have become more expensive. But shared and unpredictable supply shocks – including factory closures, shipping problems and rising food and fuel costs from the war in Ukraine – are driving much of the price hikes around the world.
That makes this moment difficult for central bankers to navigate. Their tools mainly make money more expensive to borrow, which puts pressure on demand by making people and businesses less likely to spend. But they can do little to influence the supply.
Still, officials around the world decide they can no longer wait for the shortages to be resolved. Central bankers around the world are raising interest rates to try to slow demand to a point where it is more in line with the current limited supply of goods and services.
It’s not clear when normality will return or what it will look like as companies and countries talk about bringing factories closer to home in a turn away from globalization, which kept prices low by controlling labor and production costs. to keep. And critically, rapid price increases threaten to alter consumer inflation expectations as they persist into the second year. If the outlook for price increases shifts, inflation could become a more permanent feature of the economy as households and businesses change their approach to wage negotiations, spending and price decisions.
“The risk is that through a multitude of shocks you will move to a higher inflation regime,” Mr Powell said. “It’s our job to literally prevent that. And we will prevent that.”
As inflation in the United States is at its fastest pace in four decades, Fed policymakers have quickly raised interest rates to try and control it, including a large three-quarter point rise in June. Central bankers have indicated they want to raise interest rates well above 3 percent before the end of the year, from their current range of 1.5 to 1.75 percent.
“The purpose of that is to slow growth so supply has a chance to catch up,” Powell said Wednesday. “It’s a necessary adjustment that has to happen.”
The ECB plans to raise rates for the first time in more than a decade at its July meeting, and Ms Lagarde has indicated that when the ECB raises rates again in September, it is likely to be an even bigger hike. This week, she reported that the risk of continued high inflation outweighs the slowing economic growth outlook in the eurozone.
Frequently asked questions about inflation
What is inflation? Inflation is a loss of purchasing power over time, meaning your dollar won’t go as far tomorrow as it did today. It is usually expressed as the annual price change for everyday goods and services such as food, furniture, clothing, transportation, and toys.
The Bank of England, which began raising interest rates in December, has tried to walk a “narrow road” between halting inflation, which hit a 40-year high of 9.1 percent in May, and concerns about the stagnation of the economy as the cost of living, including food, and fuel prices rise.
“If we see greater sustained inflation, i.e. second-round effects, then we will act strongly,” Bailey said on Wednesday.
The eurozone and Britain have both experienced particularly large energy price shocks, exacerbated by the Russian invasion of Ukraine. As energy prices remain high and the war drives up global food prices, central bankers in Europe are wary of the so-called second-round inflation generated by domestic firms that charge higher prices, especially in the services sector, and faster wage growth.
As central bankers around the world withdraw support, the global economy appears to be heading for a clear slowdown. The Bank for International Settlements warned in its annual report this week that there was a risk of a “stagflationary hard landing” if high inflation persists, central banks slow growth and financial markets and debt companies come under pressure.
It is not only international bodies that are concerned.
As the Fed tries to cool the U.S. economy without plunging it into recession, Mr Powell acknowledged on Wednesday that the central bank’s efforts to slow consumer and corporate demand to cool inflation are “very likely to hurt with will bring.”
The risk of a severe downturn has become more acute as the war in Ukraine keeps commodity prices high, increasing the likelihood that central bankers will have to slow growth more drastically to catch up with limited supply and push prices down.
“It’s gotten harder, the trails have gotten narrower,” said Mr. Powell on a so-called soft landing. “Yet that is our goal.”