Central bankers conspire to tackle inflation by raising rates

Inflation is running amok, faster every day and more and more everywhere.

There are few instruments to tackle it.

Among them, the increase in interest rates, but it is dangerous handling.

Because more expensive money can end up punishing investment, growth and employment, and precipitate a recession... in times of recovery!

The firmness in the willingness to increase them was this Wednesday the common thread of the central bankers who debated, at the annual ECB Forum, which is held in Sintra, next to Lisbon.

But the debate was white glove.

Not only because the lords of money tend to display courtesy.

Not because they have rehearsed it.

It happens that there is harmony, almost a conspiracy, in the orientation of making the price of money more expensive.

Only at different rates and with different warnings about its potentially negative effects.

So the European Christine Lagarde, the American Jerome Powell, the British Andrew Bailey and the president of the Bank for International Settlements, the Mexican Agustín Carstens, barely had to explain their strategy.

It was enough for them to emphasize their reasons and hopes.

And also with reasoning about what some, generally last-minute converts to monetary tightening, are now criticizing acidly after having applauded the benefits of cheap money: the presumed delay of central banks in reacting and converting the horizontal peak typical of doves with the curved and twisted hawks.

It happens that when vaccination began to cause the rebound of the economy, the problems of its speed were aggravated by the Russian crisis.

“And monetary policy cannot respond with that speed,” Carstens argued.

Where the process is more pronounced is in Europe, due to its “high energy dependency”, and “expectations [of the people and the markets, about future inflation] higher than ever”, recalled Lagarde.

That he fought this Wednesday to give more relevance to the best aspects of the situation: initial salary recovery, "very low unemployment, increased investment, savings available to be reinvested...".

And also to underline that the hardening was not inevitably brutal, but in principle in a "gradual" sequence, step by step, rise by rise.

And resorting, if appropriate, to "optionality", that is, to drastic increases if market agents conspire to artificially raise prices: "The markets know perfectly well where we are and what we want."

Notice to sailors that fingers can be caught.

The others, too, even the most hardened like Powell, showed their kindest cheek.

"For me, the most positive thing is that the central banks do their job without creating distortions in the market," celebrated the president of the Federal Reserve, praising himself in passing because his rises, of historical dimension, have not caused -at least not yet- a recession

"The most important thing at this time is that the transition [from low to high rates] be smooth," agreed the head of the Bank for International Settlements.

But each at their own pace.

So the governor of the Bank of England, Andrew Bailey, asked for respect and not to mark the calendar.

He insisted that "he is prepared to act with force, if necessary" to counter inflation that is estimated to exceed 11%.

“We will have to do more in that case”, but a further rate hike on the pound for August is not yet on the agenda.

It depends on the data, that Galician phrase that has become a categorical imperative of monetary policy.

Very suggestive has been in this conclave, although it is less of the hard news, the alert launched by the ECB —through interposed experts— on three components of that inflation: the price of housing, the bottlenecks in supplies, and society's expectations about price increases.

In a panel moderated by his vice president Luis de Guindos, Professor John Muellbauer (from Oxford) pointed out with data that the real estate market "would not be far from the perfect storm", due to the years of easy credits, which are followed by increases in rates and often lead to sharp price drops.

It has been avoided by measures calling for prudence by supervisors of banks and other creditors.

And as for the ruptures of foreign supply chains, data to think about: they account for two thirds of the inflation of the eurozone (by only half of that of the United States), according to Professor Sebnem Kalemli-Özcan (from Maryland);

and half, or 30%-40%, respectively, calculates the Austrian professor Gabriel Felbermayr.

So Europe is more punished because it is a more open economy (something positive) and more dependent (negative).

Society's expectations, herd risk

Social expectations (households, markets, professionals) about the immediate and long-term future of prices can become a risk.

"When they are un-anchored [well beyond the 2% official target] it is very difficult to un-anchor them," said ECB Executive Director Isabel Schnabel.

And there is another more immediate danger: that they become untethered at high speed, at the pace of a wild herd following a stampede signal.

Some of that has begun to happen in the last post-pandemic phase, that of war.

If that overreaction happens in the form of an intense price spiral, "then central banks will have to overreact more in their policy," warned Ricardo Reis, a professor at the London School.

His colleague Ulrike Malmendier (Berkeley) tried the behavioral/psychological explanations.

For her, the frequency of price increases in energy and food entrenches responses to underlying inflation.

The long duration increases the restlessness.

And the panic of other times entrenches misgivings.

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