The Great Inflation Trade-Off
Leading central banks are now deploying tools that should help to contain growing price pressures. But these measures will impose a high economic cost, and could push the most vulnerable economies into recession.
CAIRO – On May 4, the United States Federal Reserve raised its benchmark interest rate by half a percentage point in an aggressive attempt to curb surging US annual inflation, which currently stands at a four-decade high of 8.3%. And eurozone inflation reached a record 7.5% year on year in April, according to preliminary estimates.
These sharp, sizeable price increases – accelerated by the war in Ukraine – are raising the specter of stagflation and may significantly erode households’ purchasing power. Vulnerable lower-income groups are likely to be most severely affected because they have limited access to financial markets, making it difficult for them to smooth their consumption. Furthermore, because prices increase more for the basic goods which dominate low-income households’ consumption basket, the rich-poor inflation gap – a phenomenon economists call “inflation inequality”– could widen further.
Just a few months ago, the price stability objective was exceptionally low in the growth-inflation trade-off. Central banks, it was argued, should continue to focus on supporting the post-pandemic economic recovery. But now the critical question is whether monetary policymakers are doing enough to fight inflation. In the case of systemically important central banks, it is difficult to argue convincingly that they are considering the risks which have emerged.