Central Bankers Are Right: This Is Not Your Father’s Inflation

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Central bankers keep shrugging off the current spike in inflation as a temporary phenomenon, and they have some good reasons to do so.

A weak jobs report in the U.S. last week has cooled off talks about tapering — the phasing out of the Federal Reserve’s bond buying program.

And even if inflation in the eurozone has now reached a decade-high annual 3%, the European Central Bank will continue its pandemic-specific program until its scheduled end in March next year. And beyond that, it will keep buying bonds under the regular asset-purchase program it launched in 2014 to help it meet its inflation target.

The debate about tapering has never been about whether or not it will happen — it will, and it should, since central banks must shrink their massive balance sheets if they want to be able to meet future major crises with the type of efficiency they demonstrated when faced with the coronavirus pandemic. The immediate question is rather whether or not they should speed up the phasing out of quantitative easing because of the supposed return of inflation.

A string of surveys of business managers released last week showed that inflation isn’t only due to oil prices catching up after historic lows last year, or some goods becoming more expensive because consumers are finally spending the money they were forced to save during the many lockdowns of the past 18 months.

Cost inflation is now putting pressure on businesses, and they in turn have to choose whether they pass it on to their customers, or compress their margins by putting a priority on preserving market shares.

A slow spread of inflation throughout the economy could then contribute to make it more pervasive, and push price expectations for the future even higher among both businesses and consumers, who might in turn seek higher wages.

But is that a credible threat? Catherine Mann, the former Citibank chief economist who is now a member of the Bank of England’s Monetary Policy Committee, cautioned Monday that we should not look at the current inflation through the eyes of the traumatized generation that endured the double-digit inflation of the 1970s.

Today is different, Mann explained, in part because wages and prices were more closely indexed to each other back then, and because labor markets and wages were more tightly interrelated. 

Furthermore, she added, companies today are more reluctant to pass on cost inflation to their customers and clients.

But how long will businesses hold? Europe and the U.S. may diverge here. According to

IHS Markit

‘s most recent Purchasing Managers Index, the pace of inflation cost is at a record high in U.S. manufacturing, and “favorable demand conditions allowed finished goods prices to also rise at an unprecedented rate, as firms sought to protect their margins,” noted IHS chief economist Siân Jones last week. In the eurozone, on the other hand, IHS Markit noted “a slight cooling of input cost inflation.”

To “promote effectively the goal of maximum employment” is the first aim assigned to the Fed under its mandate from Congress, whereas the ECB’s sole remit is to achieve stable prices — which it has defined as an annual inflation of 2%. Both can find good reasons in the latest numbers or surveys to continue their bond purchases for now.