Damn if you do, damn if you don’t

This comment from Fed policymaker Mester yesterday is something close to my heart:

“I expect some improvement in inflation figures later in the year as demand moderates and capacity constraints in product and labor markets begin to ease. I m expect inflation to moderate but stay above 2% this year and next, but this forecast is contingent on the FOMC taking appropriate action.

I said it once and I will say it again. Central banks simply don’t have the right tools to deal with the latest surge in inflationary pressures.

Mester’s remarks above attempt to reassure that the Fed is doing the right thing, but is it really?

Policymakers have little choice as inflation continues to rage. Labor market conditions are tightening as the world recovers from the pandemic and there could be concerns about wage-price spirals (although I don’t see it). However, this should not be confused with a stricter policy capable of countering the factors that have caused inflation over the past year.

Ultimately, the biggest global problem right now is supply chain disruptions. Monetary policy in all its glory does not have the capacity to solve this problem. So it doesn’t matter if the Fed cuts rates to 1% or 2%. The material difference is not in interest rates, but in how supply chain issues can be resolved over the coming months/years.

Central banks are hoping that the timing of their tightening will suit the easing of supply chain disruptions around the world. This would give the illusion that their efforts are “working”.

However, it is one thing to see inflationary pressures cool and quite another to see them return to 2%.

I see the former to be the case as monetary policy tightens for some major central banks, but the latter scenario may be something that requires a lot of hope and wishful thinking for most.

Even though policymakers know this, the immense pressure exerted by soaring inflation figures is something they cannot ignore. And so, here we are. Damn if you do, damn if you don’t.


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