How does the past help us predict policy on inflation in 2023?

THERE IS A saying in the world of monetary policy: only hawks go to central-banker heaven. Among the men and women charged with managing their economies’ money, the fortitude to rein in an economy which is growing too strongly—to take away the punch bowl just as the party gets going, as a Federal Reserve chairman once put it—is among the most admired of traits. But during the 20 years prior to the pandemic, the most pressing macroeconomic problems in many of the world’s large economies were weak growth and low inflation. Central bankers were thus cruelly denied the opportunity for a virtue-signalling removal of the punch bowl.

The sharp and persistent rise in inflation which began in 2021 has, however, given today’s central bankers their moment to shine. In 2023 most countries will get inflation under control, though not without serious pain. The problem grew to distressing dimensions in 2022, after Russia’s invasion of Ukraine sent prices of food and energy skyward. Many economies saw inflation rise to levels unseen for decades. The rate of consumer-price growth peaked at 9% in America and reached a record 10.7% in the euro area—and far higher in a few particularly troubled emerging economies.

These rising prices are the result of a confluence of inflationary forces. Generous pandemic-relief measures and accommodative monetary policy fuelled a surge in consumer spending. That spending outstripped the capacity of factories and ports to respond, often because of supply problems associated with extreme weather, new outbreaks of covid-19 and other shocks. The soaring prices of oil, gas and grain, caused by the war in Ukraine, poured fuel on the fire.

As inflation rose, an intense economic debate broke out concerning how hard central banks should hit the economic brakes—by raising interest rates, for instance—in order to check price growth. Some more doveish figures counselled a light touch, arguing that because so much of observed inflation was associated with supply problems, it should in large part resolve itself. Others argued that, as long as consumers were keen to spend, an easing of price pressures in one part of the economy would leave people with more money to splash out and drive up prices in another part.

By early 2022, the latter view had begun to win over many central bankers. The Federal Reserve, which in 2021 had waited patiently for prices to ease on their own, raised its main policy rate by 0.25 percentage points in March and 0.5 points in May, and a whopping 0.75 in June, September, October and November. Yet to begin with, central bankers held out hope that inflation might be brought to heel without a growth-crushing recession. In March, the Fed chairman, Jerome Powell, said “the historical record provides some grounds for optimism” concerning the central bank’s ability to engineer a “soft landing”.

By August, Mr Powell’s tune had changed. Higher interest rates would eventually bring down inflation, he said, but “they will also bring some pain”. Other central bankers concurred. “For the first time in four decades”, noted Isabel Schnabel, a member of the board of the European Central Bank, “central banks need to prove how determined they are to protect price stability.” The Fed’s forecasts began to show an uptick in unemployment in 2023; the Bank of England’s forecast projected a drop in Britain’s GDP.

In fact, noted the World Bank, over the past half-century the world has rarely seen a shift towards growth-restricting policies as synchronised as the one that took shape during 2022. One exception was in 1982, when policymakers around the world determined to end a decade-long inflation problem. They succeeded, but in the process induced a global recession. It was a time of hardship for many people, but is considered a triumph by most central bankers. In 2023, unfortunately, the profession seems likely to welcome a new generation of heroes.■