Central Bankers Rally for Urgent Action as Global Inflation Battle Heats Up

Central bankers worldwide are emphasizing that a slow and steady approach will not be sufficient in the battle against rising inflation.

Central bankers face a delicate balancing act. They previously believed they could raise rates without severely impacting their economies. (Photo: Institute for New Economic Thinking)

Central Bankers Rally for Urgent Action

The world’s fight against inflation is intensifying, and the measures being taken are expected to bring about more serious consequences.

Bank of England Governor Andrew Bailey expressed this sentiment after unexpectedly raising interest rates by half a percentage point, stating that failure to act now could result in prolonged high inflation.

Even though inflation rates are decelerating in many countries after a year of successive interest rate hikes, they remain above the 2% target set by numerous central banks, CNN Business reported.

To combat inflation, raising interest rates is the primary tool available to central bankers. However, research indicates that there is a time lag of at least 12 months between the actions of a central bank and their effects on the broader economy.

The Federal Reserve, for instance, halted interest rate hikes at its June meeting following ten consecutive increases since the previous March. Nevertheless, several Fed officials are signaling that interest rates may rise again shortly.

Similar to Bailey’s stance, they are reluctant to risk losing control over inflation if they do not take action now.

However, time has caught up with them, and with inflation still higher than desired, the risks of doing too little to curb it are becoming comparable to the risks of doing too much.

Christine Lagarde, President of the European Central Bank, recently likened rate hikes to the ascent of an airplane heading towards its destination.

An alternative interpretation of Lagarde’s analogy suggests that if the plane does not climb to a safe cruising altitude, it may encounter turbulence that prevents it from reaching its goal of 2% inflation. This is precisely the concern troubling central bankers.

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Challenges Faced by Central Banks

One of the challenges central banks face in reducing inflation is that certain sectors of the economy do not respond to interest rate hikes.

For example, in the United States, service prices excluding energy have risen by 6.6% compared to the previous year, according to the Consumer Price Index data from May.

This increase is higher than the 5.2% rise observed the previous year, indicating that elevated service prices are proving to be sticky.

When inflation becomes sticky, and persistently high, it becomes more difficult for central banks to weigh it in. However, it is not an unconquerable obstacle.

The question lies in how much pain central banks are willing to inflict on the economy through rate hikes to achieve the desired inflation level.

Waiting too long to make such a decision also carries its own set of consequences, as noted by Michael Bordo, an economics professor and director of the Center for Monetary and Financial History at Rutgers University.

He stated, “The longer they wait, the more tightening it will take to get inflation back down.”

Research supports this claim, showing that unaddressed inflation can become even stickier over time, making it harder for central banks to control through rate hikes.

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