Here today, here tomorrow
Central bankers love the word “transitory” – possibly too much. Officials like U.S. Federal Reserve Chair Jerome Powell and European Central Bank President Christine Lagarde resort to it to explain why higher inflation doesn’t warrant a speedy reversal of ultra-loose monetary policies supporting pandemic-damaged economies. But the adjective is doing a lot of heavy lifting.
The Fed sees inflation, as measured by the personal consumption expenditures price index, overshooting its 2% target all the way out to 2024, forecasts showed on Wednesday. A day later, a Reuters exclusive revealed concerns among some European Central Bank rate-setters that euro zone inflation could be close to or even above target next year. And the Bank of England on Thursday said inflation would rise further, to slightly above 4%, in the final quarter of this year. Forecasts it published in August see inflation above the 2% target even in the third quarter of 2023.
Powell, Lagarde, and Bank of England boss Andrew Bailey are right that part of the jump in inflation this year was due to distortions related to Covid-19. And businesses and households do still need some help. For example, the Bank of England said that UK GDP was still around 4.5% below its pre-Covid level. Also, Powell signalled on Wednesday that the Fed will soon slow the pace of its bond purchases and a couple of UK rate-setters called for an early end to the Bank of England’s asset purchase programme.
But the official line of both central banks, and that of the ECB, is that inflation pressures are transitory. That stretches credulity. Supply chain disruptions, including those that are pushing up shipping costs, are likely to persist longer than policymakers anticipated; energy prices paid by households are soaring; and wages are rising and could pick up further.
If investors and households start to believe that central bankers aren’t paying enough attention to such developments, they will start to anticipate even higher inflation. If that happens, investors would demand bigger compensation for inflation risks, leading to higher borrowing costs. And households would push for higher wages, feeding price pressures.
Central bankers may have good reasons to defer tighter monetary policy but would be better off just saying so. Their own forecasts, and facts on the ground, strain their fondness for “transitory” to the limit.