The price of fighting inflation

Lhe opulent tranquility of Jackson Hole, Wyoming, is likely to clash with the tension surrounding the annual meeting of central bankers scheduled there from August 25-27. The latter are now the target of all criticism, failing to anticipate the resounding return of inflation, at the end of the crisis caused by the Covid-19 pandemic. They are accused of having allowed a monster to escape from the cage of the key interest rates which they would be unable to regain control today, or only at an exorbitant cost for the economies.

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It is true that the balance sheet of central banks for the past decade legitimately calls for criticism. Long before the “whatever it takes” era brought about by a health shock unprecedented in modern times, the maintenance of a policy of almost free money long after the 2008 financial crisis caused many disturbances. Its effectiveness has remained questionable, not to mention its negative effects on inequality. In addition, inflation may have been invisible in consumer prices, but was present through the irrational rise in equity and house prices.

There is also little doubt that the central bankers, starting with the most powerful of them, Jerome Powell, who heads the Federal Reserve in the United States, were misguided in their reading of the first inflationary signs that appeared during of the year 2021. They invariably presented them as cyclical, linked to bottlenecks attributable to the strong economic rebound brought about by the gradual disappearance of the health crisis, before being forced to admit that they were becoming structural .

In their defense, this myopia was massively shared. And the gigantic recovery plan adopted in 2021 by the American Congress under the impetus of Joe Biden has also contributed not a little to the return of inflation in the United States. Finally, it was impossible to anticipate the war in Ukraine and the accelerator of inflation constituted by the heightened and long-lasting tensions on energy prices that the Russian invasion triggered.

The risk of recession

Even if the lessons of this decade of magic money must be learned, the priority must now be on the battle to be waged against a rise in prices which is already reaching levels that are difficult to sustain in many countries. But there is no alternative to a rate hike to hope to break this spiral.

The risk is well known. This increase is likely to result in a cascade of recessions. The US Federal Reserve’s rate hike has already been followed by a contraction in gross domestic product in the first two quarters of the year, although the job market has shown its resilience by completing erase in July all the destruction of positions caused by the pandemic. The slowdown in price increases observed in August is, however, a first encouraging signal, which still needs to be confirmed.

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The euro zone, which has been even slower to react, faces the same challenge, and the same risk of stagflation. That its currency is now struggling against the dollar, for the first time in two decades, speaks well of its difficulties. Everywhere, the bitter pill of rising interest rates will have to be administered with the concern to avoid a social breakdown that would make it unacceptable, but it should still be preferable to inflation out of control.

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