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Even a global recession may not crush inflation

The lags between tighter monetary policy and lower inflation are not well understood. Central banks may have to cause more pain than they currently anticipate.

Everyone can agree on one thing about the past year. It has revealed quite how little economists understand inflation, including both what causes it and what causes it to persist.

It is likely, therefore, that economists will also struggle to predict when inflation will cool. Optimists hope that prices will once again take people by surprise, with their rise slowing sooner than expected. 

But it seems more likely that inflation will prove stubborn even as the economy slows. That will leave policymakers with a grim choice: to squeeze the economy tighter and tighter, or to let prices spiral.

The Economist 15 November 2022


What If the Fed Has to Take Rates Up to 6%?

When the Fed began raising rates in March, markets were pricing in a terminal rate of just 2.8%.  As of mid-November, that expectation has risen to 5%

Could they be forced to do even more? Absolutely.

At its September meeting, the Federal Open Market Committee’s dot plot showed a higher trajectory of rate hikes, despite a deterioration in the growth outlook.

A simple explanation for this anomaly is that the committee’s estimate of u* — alternatively called NAIRU, or the unemployment rate associated with price stability — has risen from the traditional 4%.

What if u* is even higher? A recent estimate by Fed staff put it in the 5%-to-6% range. 

Fed Chair Jerome Powell himself has said the natural rate of unemployment has “moved up materially.”

Anna Wong Bloomberg 16 November 2022 


What If Everything Goes Wrong At the Same Time?

Could 2023 be worse? Absolutely.

It is, of course, not a surprise that an exercise aimed at estimating a global downside scenario should arrive at a big negative number. 

Still, our analysis flags how easily the outcome for the year ahead could slip below already-lackluster expectations, as well as the extremity of the impact if negative shocks collide and compound.


“those who cannot remember the past are condemned to repeat it.” 

But sometimes even those who can recall the past have a selective memory and draw the wrong conclusions.  

The Volcker shock of 1979, when the US Federal Reserve, under then-chair Paul Volcker, sharply increased interest rates in response to runaway inflation, set the template for today’s monetary tightening.

Wage increases are not the main driver of inflationary pressures. In fact, even in the US, real wages have been falling over the past year. Yet that has not stopped some economists from arguing that higher unemployment and consequent larger declines in real wages are necessary to control inflation.

One would expect the supposed “adults in the room” of global macroeconomic policy to recognize the problem and seek to craft more appropriate responses. But...

Jayati Ghosh, Professor of Economics at the University of Massachusetts Amherst, is a member of the UN Secretary-General’s High-Level Advisory Board on Effective Multilateralism.

Project Syndicate 15 November 2022


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