The Fed risks reacting too slowly if inflation continues to rise


The world economy is enjoying a vigorous but divergent recovery. This is what the World Bank did Global Economic Outlook he tells us. The main reason for the resumption is the success of the vaccination program. The main reason for the divergence is the limitation of the vaccination program. Some parts of the world economy may become too hot, while others are too cold. So, be careful.

This time is really different: the recession was caused not by the need to curb excessive inflation, nor by an oil shock, nor by a financial crisis, but by a virus. Now, with the success of vaccination programs, the world is enjoying the strongest recoveries from the recession since 1945.

This is the good news. The bad news is how uneven the recovery will be. According to the Global Economic Outlook, 94 percent of high-income countries will recover their gross national product from pre-recession per capita in two years. This would be the highest part in such a short period after any recession since World War II. But the proportion of emerging and developing countries that is expected to achieve such a result this time is projected at 40 percent. It would be the lowest part after any post-war recession.

The relative success of high-income countries is due to the scale of their fiscal and monetary responses and their vaccine rollouts. Emerging and developing countries are far behind in all these aspects. Quantitative easing has averaged 15 percent of GDP in high-income countries, compared to 3 percent in emerging and developing countries. Tax support averaged 17 percent in high-income countries, compared to 5 percent in emerging and developing countries. Even so, half of all low-income countries are in debt. According to World Bank President David Malpass, the “pandemic has not only reversed gains in reducing world poverty for the first time in a generation, but has also deepened the challenges of food insecurity and rising food prices for many millions of people. ” The decision of the United Kingdom of he cut off his foreign aid the balance is amazingly expired.

The graph showing the recovery is much more widespread in high-income countries

Given all this, the most important decision to make leaders of high-income G7 countries take this week is to fund a sharp acceleration in the supply and distribution of vaccines. This will also benefit donors. The pandemic needs to be stopped everywhere so that people are really safe everywhere.

Among the high-income economies, the most important locomotive of growth is the United States, with its highly aggressive monetary and fiscal policies. U Joe Biden’s budget proposal it predicts a federal deficit of 16.7 percent of GDP this fiscal year (at the end of September) and 7.8 percent next year. Meanwhile, most members of the Federal Reserve Board expect interest rates to remain close to zero even until the end of 2023. These policies bring great benefits. But how much are they risky?

Graph showing that inflation grew very quickly in the 1970s

This has become a lot of debate. It’s not even a purely local issue. If the Fed raises rates sharply, it is likely to cause another sharp recession in the United States. That would not only be bad for America, but also bad for the world, including vulnerable developing countries.

It is this context that makes the debate on inflation particularly significant. Stephen Roach, who worked at the Fed in the 1970s, recalled Arthur Burns, the Fed chair that left the genius of inflation out of the bottle in the early 1970s. If it were repeated, it would be expensive for almost everyone. But that’s the result really likely? The answer is “yes” – not because of what has already happened, but because of the Fed’s commitment.

Graph showing that the central banks of high-income countries are expected to persist with an ultra-tight monetary policy

The inflation growth we see now can be both modest and temporary and does not influence inflation expectations, as the Fed believes. But the Fed has been reluctant to respond too slowly, especially given the fiscal expansion. This is why, in the words of Richard Clarida, vice president, “hopefully it will be approved to keep the federal funds rate in the current range of the 0 to 25 basis point until inflation reaches 2 percent (on an annual basis) and the conditions of the labor market have reached levels consistent with the [Federal Open market] Assessment of the Maximum Occupancy Committee ”.

Graph showing that the growth of big money slows down, but it is still very high

This is “outcome-based” as opposed to “forecast-based” policy. What does it mean in profane language? It means the Fed will persist with an ultra-tight monetary policy until the occupation reaches its “maximum” (unrecognizable). Given the lags between policy and results, this guarantees overlap. By the time the economy finally gets to the point when the Fed starts to tighten, it will smoke hot (at “maximum employment”) and inevitably become hotter.

That’s what happened in the 1970s. In this case, the necessary disinflation was postponed until Paul Volcker took over in 1979. The experience was brutal. Given the inevitable lags between tightening and subdued inflation, the costs are also likely to be severe. That wouldn’t matter just for the United States. Remember: the Volcker shock triggered the debt crisis in Latin America. This time, there is a lot more debt around almost everywhere. A severe monetary tightening would create even more devastation than then.

The graph showing perceptions of inflation risk increases, but remains moderate

Getting the whole world out of the pandemic crisis is far from a done deal. Much more needs to be done on this. Moreover, the new approach to monetary policy of the world’s most important central bank risks being overly serious. Responding only to the results, it is almost certain to react too slowly. It’s possible that this doesn’t matter, because expectations remain well anchored, whatever happens. I pray that this will be the case. The alternative does not bring much thought.

martin.wolf@ft.com

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