## Inflation Scares in an Uncharted Recovery

_IMF Blog, October 6, 2021_

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## Bibliographic details
- Authors: Francesca Caselli, Prachi Mishra
- Published: October 6, 2021

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### Overview and context
- Authors: Francesca Caselli, Prachi Mishra
- Date: October 6, 2021
- The economic recovery has fueled a rapid acceleration in inflation in 2021 for advanced and emerging market economies, driven by firming demand, supply shortages, and rapidly rising commodity prices.
- The World Economic Outlook forecast cited expects higher inflation to continue in coming months before returning to pre-pandemic levels by mid-2022, though risks of an acceleration remain.

### Inflation dynamics and demand slack
- Headline consumer price index inflation has been examined relative to unemployment; despite pandemic-related challenges, the unprecedented disturbance doesn’t seem to have substantially altered this relationship.
- Advanced economies:
  - Likely to face moderate near-term inflation pressure, with the impact softening over time.
- Emerging markets:
  - Estimates of the relationship between slack and inflation appear more sensitive to the inclusion of the pandemic period in the estimation sample.

### Anchoring of expectations
- Measures of long-term expectations (breakevens drawn from government bonds in 14 nations) have been stable during both the crisis and the recovery.
- Key risk question: what combination of conditions could cause a persistent spike in inflation, including expectations becoming unanchored and sparking a self-fulfilling upward spiral?
- Historical associations with de-anchoring episodes:
  - Sharp exchange-rate depreciations in emerging markets.
  - Surging fiscal and current account deficits.
- Other contributing factors to possible de-anchoring:
  - Longer-term government spending commitments.
  - External shocks.
  - Central banks perceived as unable or unwilling to contain inflation.
  - Prolonged overshoot of an inflation target can itself cause de-anchoring.

### Sectoral shocks and price dispersion
- The pandemic triggered large price movements in food, transportation, clothing, and communications.
- Despite sectoral price moves, dispersion (variability) in prices across sectors has remained relatively subdued by recent historical standards, especially compared with the global financial crisis.
- Reason cited: relatively smaller and shorter-lived swings in fuel, food, and housing prices post the pandemic — these are the three largest components of consumption baskets, on average.

### Key projections and risks (exact figures preserved)
- Advanced economies:
  - Annual inflation will peak at 3.6 percent on average in the final months of this year before reverting in the first half of 2022 to 2 percent, in line with central bank targets.
- Emerging markets:
  - Inflation reaching 6.8 percent on average then easing to 4 percent.
- Food prices:
  - Food prices around the world jumped by about 40 percent during the pandemic, posing an acute challenge for low-income countries where food purchases make up a big share of consumer spending.
- Uncertainty and upside risks:
  - Inflation may be elevated for longer due to surging housing costs, prolonged supply shortages, food-price pressure, and currency depreciations in emerging markets.
- Simulations:
  - Several extreme risk scenarios show prices could rise significantly faster on continued supply chain disruptions, large commodity price swings, and a de-anchoring of expectations.

### Policy implications and recommended triggers for action
- Central bank policy credibility and price expectations are difficult to precisely define; anchoring assessments cannot rely solely on historical data relationships.
- Policymakers must:
  - Walk a fine line between remaining patient in supporting the recovery and being ready to act quickly.
  - Establish sound monetary frameworks, including triggers for when they would reduce support to rein in unwelcome inflation.
- Possible thresholds for action include early signs of de-anchoring inflation expectations, such as:
  - Forward-looking surveys indicating de-anchoring.
  - Unsustainable fiscal and current account balances.
  - Sharp currency swings.
- Historical lessons:
  - Strong policy action has often tamed inflation and expectations.
  - Sound and credible central bank communication played an especially crucial role in anchoring views.
- Authorities should be alert to combinations of individually benign risks that together could produce a “perfect storm” of price pressures, leading to significantly more rapid increases than IMF forecasts predict.

*Source: IMF blog — “Inflation Scares in an Uncharted Recovery,” Francesca Caselli and Prachi Mishra, October 6, 2021.*

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## References

- [forecast](https://www.imf.org/en/Publications/WEO/Issues/2021/10/12/world-economic-outlook-october-2021/)

_Source: https://www.imf.org/en/blogs/articles/2021/10/06/blog-ch2-weo-inflation-scares_