analysis | Central banks cannot stop stagflation alone


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Central bankers, the shining saviors of the global economy after the global financial crisis and during the pandemic, are becoming the villains of a widespread story. Taking even the slightest bit off a stingy and inflated balance sheet for too late and too small a rate hike won’t stop inflation from skyrocketing to double digits. But falling into a recession to compensate for sleeping too long in the stimulus package would be another tasteless failure. What is needed is to make fiscal policy more of the economic burden.

When we worked together for a short time to increase government spending and align with innovative stimulus programs, we went back to the central bank as the only barrier to stagflation. The current break between fiscal and monetary policy puts the defenders of financial stability and independence at risk of attack.

The tightrope between curbing soaring inflation and stagnating the economy poses a dilemma for the European Central Bank. Removing stimulus too soon as hawks in the ruling council are calling for an imminent end of quantitative easing and a swift end to negative interest rates, and the always unstable eurozone economy could slow sharply next year. The saving grace is that, at least so far, there is little evidence of soaring wage increases. This is where the government of the bloc can help by mitigating the impact of soaring energy prices on consumers to mitigate the effects of secondary inflation.

The European Union (EU) had great success in creating a next-generation fund worth €800 billion ($840 billion) to offset the economic hardship caused by the pandemic last year, but the collective financial response to Russia’s invasion of Ukraine was minimal. . The EU’s greatest strength is its flexibility in the face of adversity. The package to sustain growth while mitigating the price impact of war must be aligned with the coordination of military and sanctions responses.

The task of the Bank of England is even more difficult given the tax increases introduced by Finance Minister Rishi Sunak. It’s not a good look to warn of an impending recession as the central bank raises rates at its fourth meeting. Rising borrowing costs could exacerbate the cost of living crisis. As such, divisions among members of the Monetary Policy Committee are growing, prioritizing the need to calm inflation and those concerned about government fiscal pressures.

The UK government does not appear to be heeding the pleas of financial experts to mitigate the coming decline in living standards. Traders and investors are, of course, increasingly wary of pound assets as the BOE is perceived as losing its will to deal with rising consumer prices and predict stagflation.

Meanwhile, the Fed sees no obstacles and is accelerating austerity. This widens the interest rate gap against other currencies, further fueling the dollar’s strength, disrupting foreign exchange markets and damaging emerging market economies especially. But the US central bank has little choice in clearing it up after the government’s excessive stimulus measures. The prospect of a political stalemate after the November midterm elections does not bode well for President Joe Biden’s already wavering administration. At the very least, with the former Fed chair now leading the Treasury, there should be hope for a synchronization between fiscal and monetary responses to the economic challenges ahead.

Aggressive deflation of the economy to cool an overheated labor market and disrupt demand is a goal pursued by the Fed and the BOE. Not only would this risk wasting trillions of dollars spent on pandemic recovery efforts, but it could also be out of control. A cure could be worse than a disease, and it is already shaking confidence in monetary authorities’ ability to get the job done.

No one wants to go back to the politicians who set interest rates. Therefore, in the midst of global supply chain disruption and the energy crisis caused by war, when the world is effectively shut down and then turned back on, we need to recognize the limitations that monetary action alone cannot achieve. Central bankers have little or no control on the supply side and can only curb the demand they have fancifully fueled in recent years. Governments can tinker with the production side, but only if it makes commercial sense. It takes a long time for infrastructure or other large-scale projects to produce meaningful economic effects, but there is much more fiscal policy can do, especially along with taxes and investment incentives.

Stocks and bonds are already burning red for impending economic risk. Fiscal and monetary policies can and should be coordinated without compromising the independence of policy makers. Now is the time to repeat the creativity shown by global authorities during the pandemic. They must act now.

More from Bloomberg comments:

• Technology stocks are entering an age of uncertainty: Parmy Olson

• Fed’s Kashkari reveals an uncomfortable truth: Lisa Abramovicz

• The US Dollar’s Horrible Strength: Marcus Ashworth

This column does not necessarily reflect the views of the editorial board or Bloomberg LP or its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was Chief Market Strategist at Haitong Securities in London.

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