Addressing Inflation Pressures Amid an Enduring Pandemic
IMF Blog, December 3, 2021
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- Authors: Tobias Adrian, Gita Gopinath
- Published: December 3, 2021
Overview
- Authors: Tobias Adrian, Gita Gopinath.
- Date: December 3, 2021.
- Core message: Inflationary pressures are intensifying amid renewed pandemic uncertainty from Omicron, requiring monetary policy responses calibrated to country-specific circumstances.
- Key judgment: Inflation is likely to be higher for longer than previously thought.
The global inflation landscape
- Global drivers:
- Rising energy and food prices have fueled higher inflation in many countries.
- High commodity food prices may continue to add to inflation in 2022.
- About 40 percent of consumption spending in low-income countries is on food.
- Core inflation patterns:
- Core consumer price inflation (excluding fuel and food) has risen but with significant cross-country variation.
- By annualized cumulative inflation since pre-pandemic, core inflation among advanced economies has risen most sharply in the United States, followed by the United Kingdom and Canada; the euro area increase is much less so.
- Limited signs of core inflationary pressures in Asia, including in China, Japan and Indonesia.
- Among emerging markets, core is dramatically elevated in Turkey.
- Median inflation:
- Recent rise in median inflation for the United States to around 3 percent in October is higher than for other Group of Seven countries.
- Inflation expectations:
- Medium- and long-term inflation expectations remain close to policy targets in most economies.
- United States: long-term inflation expectations have increased but remain close to historic averages and appear well-anchored.
- Euro area: expectations have increased from levels well below target to now close to it, suggesting better anchoring to the European Central Bank’s 2 percent objective.
- Japan: inflation expectations remain well below the target.
- Emerging markets: India, Indonesia, Russia, and South Africa show signs of anchored expectations; Turkey is an exception where the risk of expectations becoming unmoored is apparent.
Sources of price pressures
- Demand-side factors:
- Strong rebound in demand supported by exceptional fiscal and monetary measures, especially in advanced economies.
- Shift in spending toward goods over services.
- Wage pressures in some segments of labor markets.
- United States: more prolonged reduction in labor-force participation relative to other advanced economies, adding to wage and inflationary pressures.
- Supply-side factors:
- Supply disruptions caused by the pandemic and climate change.
- Shipping delays, delivery lags, and semiconductor shortages expected to likely improve in the second half of 2022 under the baseline.
- Outlook for supply-demand mismatch:
- Expect attenuation over time, reducing some price pressures.
- Aggregate demand should soften as fiscal measures come off in 2022.
- Relationship observed:
- Countries with faster recoveries to pre-pandemic trends (notably the United States) have seen sharper rises in core inflation relative to pre-crisis levels.
Varied policy action and guidance
- Historical context:
- At the onset of the pandemic, global policymakers synchronized dramatic easing of monetary policy and fiscal expansion to prevent a global financial crisis.
- Earlier policy stance:
- Central banks initially could "look through" runups in inflation driven by a few sectors and keep interest rates low to support recovery.
- Changing assessment:
- Risks of further acceleration of inflation are materializing; supply disruptions and elevated demand are lasting longer than expected.
- Real rates are even lower than before, implying an increasingly expansionary stance of monetary policy.
- Country-specific guidance:
- United States: grounds to place greater weight on inflation risks; appropriate for the Federal Reserve to accelerate the taper of asset purchases and bring forward the path for policy rate increases.
- More broadly: in countries where recoveries are further along and inflationary pressures more acute, it would be appropriate to accelerate the normalization of monetary policy.
- Communication and flexibility:
- Major central banks must carefully communicate policy actions to avoid triggering market panic with deleterious cross-border effects.
- Policymakers should remain agile, data-dependent, and ready to adjust course given extreme uncertainty, including from Omicron.
Potentially challenging spillovers and recommendations for emerging and developing economies
- Spillover risks:
- Emerging market central banks face greater risk of de-anchoring of inflation expectations and thus may need to tighten earlier.
- Tightening by advanced economies could cause capital outflows and exchange rate pressures for emerging markets, potentially requiring further tightening.
- Observed actions:
- Some emerging markets, such as Brazil and Russia, have raised policy rates sharply despite large COVID-related output shortfalls.
- Policy recommendations for emerging and developing economies:
- Prepare for increases in advanced economy interest rates through debt maturity extensions where feasible, thereby reducing rollover needs.
- Regulators should focus on limiting the buildup of currency mismatches on balance sheets.
Scenarios and uncertainties
- Pandemic-related risks:
- A variant that significantly reduces vaccine efficacy could lead to further supply chain disruptions and contractions in labor supply, pushing up inflationary pressures.
- Lower demand from pandemic developments could have opposing disinflationary effects.
- The sharp fall in oil prices following the discovery of Omicron and rapid imposition of travel restrictions signals volatility ahead.
- Policy tradeoffs:
- A more frontloaded Fed response to dampen inflation risks could result in market volatility and create difficulties elsewhere, especially in emerging and developing economies.
- To mitigate such effects, policy shifts need to be telegraphed well.
Conclusions
- Policy prescription:
- Responses to rising prices must be calibrated to the unique circumstances of individual economies.
- Clear central bank communication is key to fostering a durable global recovery.
- Where appropriate, accelerate normalization of monetary policy in economies with stronger recoveries and more acute inflationary pressures, while remaining agile and data-dependent.
- Final judgment:
- Varying inflation conditions and strength of recoveries across countries, together with sharply higher uncertainty associated with Omicron, necessitate tailored policy responses and careful communication.
Source: Addressing Inflation Pressures Amid an Enduring Pandemic (Tobias Adrian, Gita Gopinath), December 3, 2021.