Central Banks Grapple With Dual Threat of Slowing Growth, Rising Inflation

Central banks have found it increasingly difficult to deliver on the promise of low inflation, as growth worldwide has been slowing. Policymakers are now struggling with how best to maintain price stability amid potentially sluggish economic activity.

The “yardeni s&p 500/400/600 weekly fundamentals” is a blog post by the economist, Dr. Jeremy Siegel. In this article, he discusses the dual threat of slowing growth and rising inflation that Central Banks are currently grappling with.

The conflict in Ukraine is throwing a stagflationary shadow over the global economy, offering a choice for central banks: should they support slackening growth or combat soaring inflation?

Central bankers, who were already trying to anticipate when soaring inflation would be brought under control, say the conflict has to to their uncertainties as they try to reign in price rises without jeopardizing the pandemic’s recovery. They risk having to stifle their economy and raise unemployment in order to keep inflation in control.

For the time being, several of the world’s major central banks have taken serious action against inflation by tightening monetary policy. However, they are traveling without a clear road map since previous economic theories are no longer relevant in the present climate.

Klaas Knot, a policymaker at the European Central Bank and the governor of the Dutch central bank, stated, “We’re obviously confronting a very difficult and unpredictable climate.”

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‘It is crucial as a central bank not to contribute to the present uncertainty,’ said Klaas Knot of the European Central Bank.

PHOTO: REUTERS/EVA PLEVIER

According to an assessment released last week by the Organization for Economic Cooperation and Development, the conflict in Ukraine would shave more than 1% off global economic growth this year, while also driving inflation up 2.5 percentage points globally.

“Central banks must address inflation, but what are they doing about the slowdown?” “This is a poisoned chalice,” former ECB policymaker Panicos Demetriades remarked. “They can’t have it both ways.”

After U.S. inflation touched a 40-year high of 7.9% in February, the Federal Reserve hiked interest rates by a quarter point on Wednesday and forecasted six more hikes by the end of the year—its most aggressive pace in more than 15 years.

Fed Chair Jerome Powell told US senators earlier this month that he is prepared to go to any length to reduce inflation, following in the footsteps of his predecessor Paul Volcker, who raised interest rates to 20% in 1981, precipitating a recession and double-digit unemployment.

Still, Mr. Powell indicated at a press conference on Wednesday that he intended to control inflation by reducing wage growth while keeping unemployment low.

Some investors are skeptical that the Fed will be willing to take dramatic action to reduce inflation.

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Last Monday, Federal Reserve Chairman Jerome Powell announced the central bank’s first rate hike since 2018.

BRENDAN MCDERMID/REUTERS/BRENDAN MCDERMID/REUTERS/BRENDAN MCDERMID/REUT

“We believe that if inflation begins to cool off…the Fed would choose to live with somewhat higher inflation than the 2% target rather than driving inflation down to 2% at a high cost in terms of activity and the job market,” said Elga Bartsch, BlackRock’s head of economic and markets research.

According to Neil Shearing, chief economist at Capital Economics, 13 of the 16 occasions since the late 1970s when central banks boosted interest rates in the United States, the United Kingdom, and the eurozone ended in recession.

On Thursday, the Bank of England hiked its benchmark interest rate for the third time in as many policy meetings, predicting that inflation would surge beyond 8% by the end of the year, but softening its rhetoric on future rate hikes. The European Central Bank (ECB) abruptly announced earlier this month that it may cease its long-running bond-buying program by September, paving the door for the first rate hike since 2011, and rattling financial markets.

Given the fast worsening of Europe’s economic state, the continent’s physical closeness to the conflict, and its significant dependence on ever more costly energy—much of it from Russia—policymakers in Europe face an extremely tough option.

According to BlackRock estimates, the recent spike in European energy costs has lifted the region’s energy burden as a proportion of gross domestic product beyond levels seen in the early 1970s, but the US is still considerably below that level.

Inflation in the eurozone reached 5.9% in February, over three above the ECB’s goal rate of 2%.

Mr. Knot believes that recent economic shocks have heightened the likelihood that firms and consumers anticipate inflation to remain high, possibly creating a self-reinforcing price spiral in which businesses set higher prices and employees demand higher salaries to compensate.

Mr. Knot said, “It is critical as a central bank, especially under these circumstances, to not contribute to the current uncertainty, but to be a predictable player and to be unambiguous about our commitment” to bringing inflation to goal.

Chairman Jerome Powell of the Federal Reserve said that interest rates would be raised by a quarter percentage point from near zero. Powell also hinted at intentions to gradually raise rates this year in order to keep inflation in check. The Board of Governors of the Federal Reserve System is seen here.

Other central bankers are more concerned about the European economy’s slowing recovery from the Covid-19 outbreak.

The conflict in Ukraine, according to Yannis Stournaras, an ECB policymaker and the governor of Greece’s central bank, would raise inflation in the near run but lower economic activity and so impact on inflation in the long term. Mr. Stournaras said, “These opposing pressures generate a greater range of risks than normal concerning our inflation estimates.”

“Central banks have no script,” said Katharine Neiss, a former Bank of England economist who now works for PGIM Fixed Income in London. “I’m concerned about Europe’s sluggish growth in the face of rising inflation, a stagflationary situation… The ECB has lost some influence over the inflation story.”

The jump in inflation has often astonished central banks, despite projections that it would fall down. According to the minutes of the meeting, ECB policymakers discussed recent failures in the bank’s staff economic predictions and whether to place more weight on their own judgment and polls.

“Given the present great uncertainty, it’s prudent to have an open mind and watch how things evolve,” said Robert Holzmann, an ECB policymaker and Austrian central bank governor. He said he thought it was critical to revert to a more neutral monetary policy posture and higher interest rates, but that the bank needed to do it “step by step.”

South Korea’s, New Zealand’s, and Singapore’s central banks have already began hiking interest rates to combat inflation, with further tightening on the way. In March, Australia’s central bank kept its hands off, but investors anticipate it to start boosting borrowing prices in the coming months. The Monetary Authority of Hong Kong boosted its benchmark interest rate on Thursday in order to maintain its currency peg to the US dollar. In reaction to steady growth, growing inflationary pressure, and the Fed’s decision, Taiwan’s central bank boosted its benchmark interest rate last week.

Other Asian central banks may be pushed to tighten policy even while their economies deteriorate. The Philippines and India are dealing with rising prices and a bleak outlook for development. Thailand is experiencing growing inflation at the same time that tourist income anticipated from Russian and Chinese visitors have vanished.

In India, inflation has been over the central bank’s goal range’s upper limit of 6% for two months, and growth has slowed. For the time being, Indian central bank officials say they are more concerned about economic concerns than inflation.

In a speech earlier this month, Michael Debabrata Patra, deputy governor of the Reserve Bank of India, claimed that “the global economy is being driven to the brink of a cliff” due to war, sanctions, and the potential of financial-market volatility.

Central banks in Asia, on the other hand, are under less pressure to hike rates. China and Japan, for example, Asia’s two biggest economies, are unlikely to follow the Fed in tightening policy anytime soon. Domestic inflationary pressures in both countries remain low, implying that the impact of higher commodity prices on growth would be greater than on inflation, allowing the People’s Bank of China and the Bank of Japan to maintain loose monetary policy to boost development.

Tom Fairless can be reached at [email protected]

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The “yardeni research review” is a study that was done by the “Yardeni Research Review”. The study explains how central banks grapple with the dual threat of slowing growth and rising inflation.

Frequently Asked Questions

What do central banks do when inflation is high?

A: When inflation is high, central banks use monetary policy tools like raising interest rates to reduce demand for money and slow down the economy. They can also sell assets or print more money.

Can central banks cause inflation?

Why do central banks want inflation?

A: Central banks want inflation due to the fact that it encourages people in general to spend more of their money. This creates employment and helps keep a healthy economy.

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