There are no simple solutions to curb rising inflation, yet central banks will be expected to find them as political fallout mounts.
Central bank governors are among the best educated of the financial élite but they cannot perform miracles – which is what politicians are asking them to do.
As inflation rears its ugly head, the first task of the central bank should be to keep it under control. But the policy response to deliver this is politically unpalatable: raising interest rates.
To make matters more difficult, other economic challenges, such as slowing economies or the fear of slowdown, excessive financial inflows and overly rapid currency appreciation, invite the opposite response: that rates be cut.
Too much to ask
Central bankers may be smart but they cannot square these opposing forces entirely and no-one should expect them to. Economic policy-making is always a trade off between competing desirable and undesirable outcomes. Getting it somewhere in the middle is the best that can be hoped for.
In the UK and the US, the problem is combating inflation alongside trying to kick-start stalled economies. In China, inflation is at a 12-year high of 8.5% as a result of excess demand, driven by huge inflows of funds. Monetary policy is being tightened but the rapid appreciation of the currency that would logically follow is being resisted for fear of derailing China’s magnificent export machine.
In Brazil, the currency has surged in recent years to the point at which exports are already being damaged, and interest rate cuts would seem appropriate, especially as Brazilian rates, at 11%, are among the highest in the world. But central bank governor Henrique Meirelles disagrees and has started raising rates in response to inflation levels busting through the 4.5% target.
Political fallout
The political impact of resurgent inflation in some countries is materialising in the form of protests in the streets as rising food and energy prices hit poor people where it hurts most.
In Russia, where inflation has reached 14.3%, thousands of people demonstrated on May Day against increasing living costs; and India’s 7.65% inflation is threatening to throw huge sectors of the population back into poverty.
The Indian central bank is limited in what it can do because much of its inflation problem is caused by factors beyond its control: constraints on supply, poor infrastructure and inefficiencies, which all require long-term solutions. But do not expect the combined power of India’s poor and politicians to appreciate that.
As always, there are no simple answers, yet central banks will still be expected to find them.
If you were thinking of taking up a career as a central bank governor, now might not be the best time.
