Central banks around the world risk losing public confidence and must act forcefully to combat inflation, even if that pushes their economies into a recession, European Central Bank board member Isabel Schnabel said on Saturday.
Inflation is rising sharply in many of the world’s biggest economies and any fall is likely to be slow, keeping price rises above central bank targets for years to come, she noted.
The coronavirus pandemic, and more recently Russia’s invasion of Ukraine, may herald a turning point for the macroeconomic stability the world has largely enjoyed for over a decade since the global financial crisis of 2008 and inflation has surged beyond what was experienced in the 1970s, she said in a speech.
While the exceptional effects of the pandemic and the Ukraine war may eventually wash out from the data, leading output and inflation volatility to decline, climate change may expose the global economy to greater volatility in output and inflation, she argued.
“This summer, the European Union – like many other parts of the world – is suffering from one of the most severe droughts on record, with nearly two-thirds of its territory in a state of alert or warning,” she noted.
However, history is full of examples of high and persistent inflation causing social unrest, she argued. “Recent events around the world suggest that the current inflation shock is no exception. Sudden and large losses in purchasing power can test even stable democracies.”
“Even if we enter a recession, we have little choice but to continue the normalization path,” Schnabel told the U.S. Federal Reserve’s Jackson Hole Economic Symposium in Wyoming. “If there was a de-anchoring of inflation expectations, the effect on the economy would be even worse.”
The European Central Bank, responding to fears of runaway inflation, delivered its first interest rate hike in 11 years on July 21 — and made it a big one.
The ECB announced it would lift its key interest rates by 50 basis points, or half a percentage point, while also announcing the approval of a new tool designed to keep yields on bonds of stressed eurozone countries from spiraling to unsustainable levels.
Schnabel also cautioned central banks against letting up on tight monetary policy at the first sign of a turn in inflation. Policymakers should instead signal their “strong determination” to bring inflation back to target quickly, she said.
“Both the likelihood and the cost of current high inflation becoming entrenched in expectations are uncomfortably high,” Schnabel said. “In this environment, central banks need to act forcefully.”