The fight against inflation will bring another wave of sacrifice

“Pain”, “sacrifice”, “end of abundance”.

For the flesh and blood economy, there is no better early indicator of a crisis than the morality that is beginning to permeate economic rhetoric.

Analysts traditionally look at data on industrial orders, freight traffic or consumer confidence, among other metrics, to detect the first signs that something is wrong.

They are usually significant.

But no index detected the Great Recession of 2008 better and faster than that of the sobering words: that living “beyond our means”, those metaphors of diets and castor oil.

US Federal Reserve Chairman Jerome Powell warned last week that "a little bit of pain" was coming for families and businesses.

The counselor of the European Central Bank, Isabel Schnabel, pointed to the probable need for "sacrifice".

The President of France, Emmanuel Macron, had announced a day earlier "the end of abundance."

The claw of inflation, the energy crisis and the fear of recession have caused the fire this time.

It is not clear how serious the decline that is coming is, but on both sides of the Atlantic that infallible indicator of language has already warned: curves are coming.

01:02

Macron begins the political course by decreeing the "end of abundance" in the country

The French president, Emmanuel Macron, at the Elysée Palace on August 24. Video: EPV

“Nothing poisoned the German people so much—it should be remembered forever—nothing so inflamed their hatred and ripened them so much for the advent of Hitler as inflation,” wrote Stefan Zweig in his celebrated memoir

.

The writer remembered the hyperinflation of the Weimar Republic with astonishment, recounted how a family ended up needing millions of marks to get through the day, they could hardly find coal to heat themselves in winter, the value of the currency sank and "vultures" with foreign currency they hoarded everything.

The runaway and continuous rise in prices, one of the economic phenomena most feared by governments, has now returned to levels unknown in 40 years and this time, there is not too much "vulture" safe.

The lack of control punishes a good part of the developed economies.

Europe, the United States, Canada or the United Kingdom exceed or are close to a two-digit inflation rate, when orthodoxy indicates that it should remain around 2%.

And the central banks, which determine monetary policy and have the mandate to control inflation, have sounded the rebuke.

When the situation gets out of control, the manual recommends raising interest rates, that is, making loans to companies and households more expensive, in order to clamp down on demand and stop the galloping of prices.

“Reducing inflation is likely to require a sustained period of below-trend growth.

In addition, labor market conditions are very likely to weaken.

While higher interest rates, slower growth and weaker labor market conditions will reduce inflation, they will also spell some pain for households and businesses.

These are the unfortunate costs of reducing inflation.

But if price stability is not restored, the pain will be much greater,” Powell warned on August 26, at the traditional monetary policy symposium held each year in Jackson Hole, Wyoming.

There is at least one

and one doubt.

The

is that, in this inflationary crisis, the strength of the labor market and the appetite for spending is only one of the causes.

Not even the main one in the case of Europe.

The energy crisis, the war in Ukraine and problems with supply chains have combined with the strength of the economy and the usual toolbox of central bankers has no answer for that.

And the question is how much of that "pain" that Powell cited is needed.

If it is possible to proceed with the de-escalation without entering a recession or a long stagnation, what the institution calls an "immaculate disinflation".

Aggressiveness

History says that, most of the time, that soft landing does not happen.

Alan Greenspan's Fed did it in the 1990s, raising the price of money to 6%, but the rate of inflation was almost half that and its motives less complex.

In Washington and Frankfurt, the ghost of the 1970s is much more present these days, when then Fed Chairman Arthur Burns was complacent with high inflation and it lasted for a decade.

It was Paul Volcker, considered the patron saint of the Fed, who solved the problem in the 1980s by shooting up the price of money up to 20%, at the cost, yes, of two economic recessions.

Inflation had climbed to 14%.

What will happen this time?

Analyst Desmond Lachmand is very critical from the American Enterprise Institute, a conservative

in Washington.

“Inflation will be brought under control, but there will be a cost, and it will be a recession.

Central banks have no choice but to slow down the economy, but I think they are doing it too aggressively, at least at the Fed, and may cause a harder than necessary recession,” he says.

"The mistake they made was not to act last year, when they were convinced that inflation was a transitory problem, and now they are going to pay the price," he adds, and clarifies: "Well, no: we are going to pay the price" .

The adjustment is already beginning to penetrate the street, in hard-earned euros.

Mortgages became more expensive in August at the highest rate since 2000 due to the rise in the Euribor.

This rebound aggravates the punishment in the pockets of citizens, who pay more, much more, for almost everything: gasoline, food, electricity bills.

The energy crisis is weighing down the economy —the Ferroatlántica metallurgical company has just stopped its furnaces in Cantabria due to the cost of supply—, and the uncertainty is already causing the first disappointments: Ford has decided to delay the plans to manufacture electric cars in Almussafes (Valencia) within a program of cuts that he has just approved.

The Ibex-35, the selective benchmark of the Spanish Stock Exchange, chained this week its worst streak since it was created, in 1992: 12 days in a row in red.

Many economists take the recession in the United Kingdom and the euro zone for granted, but not because of the work and grace of the central banks, but rather because of that energy cocktail, the very ballast that inflation represents and doubts about the future.

The tightening of monetary policy is the icing on the cake.

Russia has just announced that it is cutting off gas to Europe and Germany, the group's great economic locomotive, is one of the big losers.

BBVA Research forecasts a couple of negative quarters for Spain's GDP —which technically defines a recession—, but a positive balance for 2023 as a whole. Rafael Doménech, head of economic analysis for this cabinet, underlines the need to anchor expectations of inflation, that is, to prevent the forecast that prices will continue to run wild, feeding back wages and costs in an endless spiral.

Central bank adjustments contribute to them.

“Otherwise, the rate hike will have to last longer,” he warns.

Again, the ghost of the 70s.

In general, there is a consensus on the need to continue raising rates after more than a decade of strong monetary expansion and with red-hot inflation, above all, taking advantage of the fact that the labor market is robust to accept the blow (at all-time highs in the euro zone and at full employment in the United States).

The debate between

(guardians of orthodoxy) and

(defenders of heterodoxy) lies in the speed of this adjustment, as reflected in the minutes of central bank meetings.

Isabel Schnabel, German ECB adviser, said in Jackson Hole that there were two alternatives: act with prudence, since inflation is due to external shocks and rates may not solve it, or proceed decisively even at the risk of "lower growth and higher unemployment".

She defended the second path, adding as a tip: “Central banks are likely to face a higher sacrifice ratio than the 1980s […] due to the globalization of inflation.”

High volatility

"I hope you live in interesting times," says a supposed Chinese curse that is often mentioned when talking about monetary policy.

These times are proving devilishly interesting for central bankers.

They have not had to respond to an inflationary challenge like this in 40 years and they do so, moreover, in an unprecedented scenario that puts their usual weapons in check: job creation is more difficult to predict with the pandemic, climate change has Increased volatility in energy and food prices, and the protectionist shift caused by covid-19 and geopolitical tensions cast doubt on supply.

“The so-called

, the principle according to which, if inflation stabilizes at the target, the optimum level of economic activity is also reached, it is no longer fulfilled”, explains the economist Ángel Ubide.

The three decades after the 1980s are known as the era of the "Great Moderation" because of the relative smoothness of economic swings.

Schnabel warned of the danger of entering an era of "Great Volatility" and highlighted the role that governments' fiscal policy must play to prop up the economy before

.

The United States managed to ease inflation slightly in July (largely due to the respite from oil) and, at least until the Russian gas cutoff, there have been reasons to think that the trend will be replicated in Europe.

But if a forceful slowdown in prices is not achieved —due to energy and other external shocks— and, at the same time, economic activity enters a long period of lethargy, another ghost is stirred, that of stagflation: high inflation, low growth and job destruction.

Objective: neutral rate

“With the current level of inflation, an interest rate that is at least neutral [that controls inflation without weighing down growth] is necessary, the Fed already has it and the message from the ECB goes in that direction,” says Ubide.

The Governor of the Bank of France, Francois Villeroy de Galhau, believes that the ECB's neutral rate is between 1% and 2%.

"The question is what happens next, if they are willing to continue rising to slow down the economy," adds the economist.

The United States has a somewhat easier time containing the escalation because its inflation is more linked to demand.

The success of the central banks in this battle against inflation will be seen, says Ángel Ubide, “once the energy crisis is over”.

The International Monetary Fund (IMF) has reminded governments that other policies can address the risk of a slowdown.

The body's

, Gita Gopinath, launched a few recommendations last week: she warned that emergency aid should be directed to people in need and thus avoid becoming a fiscal stimulus and urged to take measures for the climate transition and policies that promote the diversification of world trade.

Interventions in the electricity market can also contain prices.

Philipp Heimberger, from the Institute for International Economic Studies in Vienna, stresses the loss of purchasing power that European workers are already accumulating, whose wages have not kept pace with inflation, and calls the central banks' communication strategy, their accent on sacrifice.

There is nothing haphazard about such language, according to David Wilcox, an economist at the Peterson Institute for International Economics and Bloomberg Economics.

“Powell has wrapped himself in the robes of Volcker [he of disinflation and 1980s recessions] and has said that he understands the responsibility to control inflation, without excuses, and that he is determined to do it and will do whatever it takes,” he emphasizes.

ECB President Christine Lagarde

It is, in short, another version of

(We will do whatever it takes) made famous by Mario Draghi at the head of an expansionist ECB in the euro crisis.

A version in the opposite direction.

This week in Frankfurt the European body will give another clue as to how opposite.

These are, the curse says, interesting times.

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