Central Bank Thinking in Addressing the Spike in Inflation

December 17, 2021

The following excerpts from the Bank of Russia governor explaining today’s sharp interest rate hike epitomized the dilemma of many central bankers around the world coming to terms with an inflation spike caused by mostly supply bottlenecks that has lasted longer than anticipated.

Our special focus is to ensure that the monetary policy is well-balanced. What do we mean by that? It is the stable component of inflation related to demand trends that monetary policy impacts directly. However, we should not ignore temporary factors. According to the experience of the last three months, these factors are not only accelerating overall price growth, but are also intensifying inflation expectations. Hence, temporary factors are becoming steady. When inflation expectations remain high, we need more time and a more significant tightening of monetary policy to be able to return inflation to the target. If we delay this, both inflation and inflation expectations will continue to go up.

Of course, a very tight policy aggressively responding to transitory factors could bring inflation back to 4% more quickly. However, this would entail a slump in economic activity and a subsequent considerable deviation of inflation downwards from the target. The objective of a well-balanced monetary policy is to ensure price stability and limit sharp fluctuations in inflation, whether upwards or downwards.

The Board of Directors believes that we have apparently not yet tightened monetary conditions to the extent needed to bring inflation back to the target next year. Therefore, we hold open the prospect of a further key rate increase at the upcoming meetings. Nonetheless, the situation might change. At the next meeting, we will consider how our today’s and earlier decisions, given the time lags, influence monetary conditions, among other factors. We will take into account that, even with the key rate unchanged, monetary conditions might toughen if inflation and inflation expectations go down.

The stress on achieving balance in the above passages illustrates the extreme uncertainty through which economies and policymakers are currently navigating. Markets by their nature hang onto every word of forward guidance from central banks as if such represent the last word. But in the current very very dynamic circumstances, policymakers don’t really have a firm grasp of what they will be doing, only that they will be guided by where all the data yet to come takes them. As best as they can, officials are trying to lean in the direction that if their actions and timing prove wrong, at least the resulting damage will be smallest. That’s easier said than done. Fundamentally, the surest way for economies to transition to a tolerable post-pandemic new normal lies in containing Covid once and for all, and wider vaccination and masking on a global level is the best way to secure those objectives. Economic policymaking will be subordinated to getting public health policy correct.

Copyright 2021, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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