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Central banks accept pain now, fear worse later

A day after the Federal Reserve slashed interest rates and signaled more to come, central banks in Asia and Europe followed suit Thursday, waging their own campaigns to squash a bout of inflation that is plaguing consumers and worrying politicians around the world.

Central bankers typically move slowly. That’s because their policy tools are blunt and work late. The interest rate hikes taking place from Washington to Jakarta will take months to filter through the global economy and take full effect. Jerome H. Powell, federal president, once similar policy making to walk through a furnished room with the lights off: walk slowly to avoid a painful outcome.

But officials, learning from a story that has illustrated the dangers of taking too long to stamp out price increases, have decided they no longer have the luxury of patience.

Inflation has been relentlessly fast for a year and a half. The longer it stays that way, the greater the risk that it will become a permanent feature of the economy. Labor contracts could begin to take cost-of-living increases into account, businesses could begin routinely raising prices, and inflation could become part of the fabric of society. Many economists believe that happened in the 1970s, when the Fed tolerated uncontrolled price increases for years, allowing an “inflationary psychology” to take hold that later proved unbearable to crush.

But the aggressiveness of now-underground monetary policy action also pushes central banks into new and risky territory. By tightening rapidly and simultaneously when growth in China and Europe is already slowing and supply chain pressures are easing, global central banks risk overreacting, some economists warn. They can plunge economies into recessions that are deeper than necessary to curb inflation, driving up unemployment significantly.

“The margin of error is now very small,” said Robin Brooks, chief economist at the Institute of International Finance. “A lot of it comes down to the trial and how much emphasis to put on the 1970s setting.”

In the 1970s, Fed policymakers raised interest rates in an attempt to control inflation, but backed off when the economy began to slow. That allowed inflation stay elevated for years, and when oil prices soared in 1979, they reached unsustainable levels. The Federal Reserve, under Paul A. Volcker, eventually raised rates to nearly 20 percent, and raised unemployment to more than 10 percent, in an effort to fight price increases.

That example weighs heavily on the minds of politicians today.

“We think that failing to restore price stability would mean a lot more pain down the road,” Powell said at his news conference on Wednesday, after the Fed hiked rates by three-quarters of a percentage point for the third time in a row. The Fed expects to raise borrowing costs to 4.4 percent next year in the fastest tightening campaign since the 1980s.

The Bank of England raised interest rates by half a point to 2.25 percent on Thursday, even as it said the UK may already be in a recession. The European Central Bank is equally expected to continue raising rates at its October meeting to combat high inflation, even as Russia’s war in Ukraine throws Europe’s economy into turmoil.

As major monetary authorities raise borrowing costs, their trading partners do the same, in some cases to avoid big moves in their currencies that could push up local import prices or cause financial instability. On Thursday, Indonesia, Taiwan, the Philippines, South Africa and Norway all raised rates, and a big move in central bank of switzerland ended the era of sub-zero interest rates in Europe. Japan has comparatively low inflation and keeps rates low, but on Thursday it intervened in currency markets for the first time in 24 years to prop up the yen in light of all the action from its counterparts.

The wave of central bank action is expected to have consequences, working by design to drastically slow both interconnected trade and national economies. The Fed, for example, expects its measures to push US unemployment to 4.4% in 2023, from 3.7% today.

The movements are already beginning to have an impact. Rising interest rates are making it more expensive to borrow money to buy a car or home in many nations. Mortgage rates in the United States are back above 6 percent for the first time since 2008, and the housing market is cooling off. The markets have fainted this year in response to tough talk from central banks, reducing the amount of capital available to large companies and cutting the wealth of households.

However, the full effect could take months or even years to be felt.

Rates are rising from low levels, and the latest moves haven’t had time to fully play out yet. In continental Europe and Britain, the war in Ukraine, rather than monetary tightening, is pushing economies into recession. And in the United States, where the fallout from the war is much less severe, hiring and the labor market remain strong, at least for now. Consumer spending, while slowing, is not plummeting.

That’s why the Fed believes it has more work to do to slow the economy, even if that increases the risk of a recession.

“We have always understood that restoring price stability while achieving a relatively modest rise in unemployment and a soft landing would be a major challenge,” Powell said Wednesday. “Nobody knows if this process will lead to a recession or, if so, how significant that recession would be.”

Many global central bankers have described today’s inflation outburst as a situation where their credibility is on the line.

“For the first time in four decades, central banks must demonstrate how determined they are to protect price stability,” said Isabel Schnabel, a member of the executive board of the European Central Bank, told a Fed conference in Wyoming last month.

But that does not mean that the policy path that the Fed and its counterparts are forging is unanimously agreed upon, or unambiguously, that it is the right one. This is not the 1970s, some economists have pointed out. Inflation has not risen for so long, supply chains seems to be healing and measures of inflation expectations stay under control.

Mr Brooks of the Institute of International Finance sees the pace of tightening in Europe as a mistake, and believes the Fed might also overreact at a time when supply shocks are fading and the full effects of policy measures are fading. recent policies are not yet known. finish

Maurice Obstfeld, an economist at the Peterson Institute for International Economics and a former chief economist at the International Monetary Fund, wrote in a recent analysis that there is a risk that the global central banks will not pay enough attention to each other.

“Central banks are clearly rushing to raise interest rates as inflation reaches levels not seen in nearly two generations,” he wrote. “But there can be too much of a good thing. Now is the time for monetary policy makers to lift their heads and look around.”

Still, at many central banks around the world, and most notably at Powell’s Fed, policymakers see it as their duty to remain resolute in the fight against price increases. And that is translating into forceful action now, regardless of the looming and uncertain costs.

Mr. Powell may have once warned that moving quickly in a dark room could end painfully. But now, it’s as if the room is on fire: the threat of a stubbed toe still exists, but moving slowly and cautiously risks even greater danger.

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