Lhe remarks by US Federal Reserve Chairman Jerome Powell at the August 26 meeting of central bankers in Jackson Hole grabbed headlines. His message was clear: the Fed must do everything to curb inflation, even if the US economy and labor market slow down. This message disappoints investors, who had hoped the Fed would back off from tightening monetary policy, and stock markets have crashed in the meantime.
In his remarks, Powell acknowledges that the current high inflation is the result of strong demand and limited supply, and that the Fed’s tools primarily act on aggregate demand. However, he maintained that “This in no way diminishes the responsibility of the Federal Reserve to carry out the task entrusted to it, namely to ensure price stability”.
Many observers, however, question the advisability of tackling global supply shocks by raising interest rates significantly. In their eyes, the Fed could make a strategic error that would harm the economy and lead to the destruction of many jobs.
The fight against inflation, a priority
Skeptics should, however, read the remarks by Isabel Schnabel, member of the Executive Board of the European Central Bank (ECB). This argues for a tightening of monetary policy by central banks, even as the global economy slows. The ECB has also raised its key rates by 75 basis points despite fears of a recession in the European Union. The Fed did the same at its monetary committee meeting on September 21.
Isabel Schnabel’s thesis is indeed that the world economy is moving away from “great moderation” which has been accompanied by economic prosperity and relative macroeconomic stability for three decades. During this period, central banks played an important role in successfully keeping inflation low, which boosted consumer and business confidence.
By comparison, the past three years suggest that we may be entering a period of “great volatility”, with the global economy reeling from the Covid-19 pandemic, Russia’s invasion of Ukraine and the effects of climate change. According to Mme Schnabel, although these events are likely to lead to a slowdown in the economy, the decisions taken by central banks to fight inflation can mitigate and limit the final impact of these shocks.
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