Beating inflation will take more than rate hikes

Few central bankers are remembered as truly brilliant. You rarely see statues paying homage to skillful monetary policy. If the world quickly manages to escape its current rut of high inflation and low growth, central bankers in the UK, US and EU will certainly have gained some recognition. For now, that seems a distant prospect.
There are reasons to think that central bankers have been too slow to tighten over the past year: inflation has been out of the comfort zone for months. But the scale of the current inflation spike – which stands at 8.3% in the US, 7.5% in the eurozone and 7% in the UK (with an expectation that it will reach 10% by the end of the year) – is largely unrelated to these judgments. Monetary authorities, reflecting in months and years, have been hit by rapid shocks from supply chain lockdowns, China’s zero Covid policy and Ukraine.
Their challenge now is to bring inflation back within normal bounds over the medium term and avoid drifting into a cycle where expectations lead to consistently higher rates of inflation. It would be easier to tackle this type of problem, and the higher policy interest rates it demands, in a context of robust growth. But we are where we are. This is the kind of moment that independent central banks are built for: they must be ready to tighten even if their economies plunge.
Both the United States and the United Kingdom have started a rate hike cycle. The Bank of England has set out plans for tougher policy although it also predicts Britain is heading for economic contraction. But setting rates is only part of the answer to the problems central banks are currently facing: they are fighting expectations as well as the current surge in inflation – and that is a battle fought by communication.
Last week, Jay Powell, Chairman of the Federal Reserve, was very clear: “Inflation is far too high and we understand the difficulties it is causing, and we are acting quickly to bring it down. We have both the tools we need and the determination it will take to restore price stability on behalf of American families and businesses.
This is a succinct statement. It’s the kind of stuff the media picks up and communicates in plain language to businesses and workers that prices won’t continue to skyrocket forever. Yes, he’s probably overdoing his control of events – but he did better than BoE Governor Andrew Bailey this week.
Bailey told MPs that “we have to get [inflation] back to target. And it is clear. But he also said, “Predicting and forecasting 10% inflation and saying there’s not much we can do, about 80%, that’s extremely difficult.” He admitted he looked “apocalyptic” on food prices. This thoughtless aside drowned out much of the rest of his message. And repeating a call for restraint on wage demands was not only rude, it underscored his lack of tools.
Bailey’s mistake is to forget that his job is not just to be an analyst; it’s about managing and shaping expectations. The UK faces a particular inflationary danger. The BoE already expects a longer-lasting inflation problem than other economies. Its labor market is ultra tight and price shocks have already spread far from food and energy.
For ECB President Christine Lagarde, the mission is equally clear: to keep expectations anchored. Eventually he will have to stop stimulating the economy to show that he is serious. His work, however, is a bit different. It is more exposed to the war in Ukraine, which will weigh on growth. And underlying inflation in the euro zone is not as high as in the United States.
The monetary authorities have had a few difficult months. But the job of central bankers is not just to worry about interest rates or the details of asset sales. Their job is also to persuade and lead.