Opinion: The Fed and other central banks can’t control inflation — and may not want to

Despite strident denials, rising prices in fact might be consistent with policymakers’ objectives

The world’s central banks may lack the necessary tools to control inflation this time around. Yet despite their strident denials, rising prices in fact might be consistent with their objectives. 

Contrary to central bank messaging about low- and transitory inflation, consumer prices are rising globally in the U.S. (7% annually), Canada (4.8%), the U.K. (5.4%), Australia (3.5%) and New Zealand (4.9%), to name a few.

Inflation is always about demand and supply. Nowadays, demand has been underpinned by low interest rates, central bank liquidity and fiscal expansion financed by quantitative easing. Central banks have injected more than $32 trillion (equivalent to buying $800 million of financial assets every hour for the past 20 months). Some of this often poorly targeted support has been excessive, substantially exceeding declines in income. Infrastructure spending and industry incentive have exacerbated the problem. 

Both short- and long-term supply issues have boosted prices. Oil prices have risen four-fold since the artificial lows of 2020. Energy politics combined with a poorly planned and executed energy transition to renewables are key factors. Higher food prices reflect extreme weather, especially droughts and floods and national stockpiling. 

The COVID-19 pandemic has disrupted labor availability and production. A zero COVID policy in China, the world’s factory, has meant periodic interruptions of production and port traffic. Transport links have been affected, resulting in higher prices, delays and increasing unreliability. Diversion of resources to address the virus has created shortages. 

COVID has increased cost structures. Debt incurred to cover revenue shortfalls must be  paid for in higher taxes, where incurred by governments, or income, in the case of businesses. Businesses face rising expenses to meet COVID-relatd public health regulations. The lasting effects on worker mobility and labor costs remains uncertain.

One ignored factor is geopolitics, particularly the Sino-American economic war. Trade restrictions and sanctions combined with hoarding and re-shoring production has affected everything from PPE, semiconductors, rare-earth minerals and technology transfers. This has reduced availability and pushed up prices.

Read: China’s slowing growth and massive debt threaten stock and bond investors worldwide

In dealing with price pressures, monetary policymakers face several complications. Traditional economic models such as the Phillip’s Curve, which describe the trade-off between unemployment and inflation, have proved deficient in recent times. 

Managing spending and demand

Available tools mainly act on demand. Winding back government spending, increasing rates and reversing loose monetary policies may curtail demand. But the risk is that an economy addicted to stimulus will stall out, compounding other problems. Rising interest rates are even more problematic. With inflation running high, rates would have to climb sharply to be an effective deterrent.