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The number one challenge for central banks around the world: fight inflation or protect growth?

A major issue currently facing central bank governors worldwide: global supply chain disruptions

Editor's note:Federal Reserve Chair Powell, at the Jackson Hole central banking conference on Friday (August 27), indicated that the Fed might begin tapering its bond-buying program this year. However, his wording left open the possibility that it might not happen, and interest rate hikes are not yet on the table. In his speech, Powell mentioned that the significant rise in inflation is only a temporary phenomenon; employment momentum is strong but could improve further; the Delta variant may or may not impact economic recovery. Additionally, he did not answer investors' most pressing questions: when exactly will the Fed start tapering? How long will tapering last?

The stock market clearly welcomed Powell's remarks, interpreting that the Fed would not soon stop implementing measures to support economic growth. The Dow closed up 0.7%, the S&P 500 gained 0.9%, and the Nasdaq rose 1.2%, with both the S&P 500 and Nasdaq hitting new highs. Barron's noted that while the Fed reiterated that inflation is only temporary, the reality may be more severe. Meanwhile, amid a resurgence of the pandemic, central banks around the world face the dilemma of whether to fight inflation or protect growth. From the current situation, it appears central banks clearly prioritize the latter.

Global supply chain disruptions perfectly illustrate a major challenge currently facing central bank governors. Closures of container ports in China, semiconductor shortages, extreme weather, and truck driver shortages due to Brexit are all factors causing global supply chain disruptions, which could slow down the pace of global economic recovery. At the same time, supply shortages have led to rising prices, as evidenced by the sharp increase in the inflation rate in 2021.

Under normal circumstances, a slowdown in economic growth and rising inflation are an abnormal phenomenon, but this year, such a situation may become the norm. So between rising prices and slowing economic growth, which problem should central bankers address first? Although specific situations vary due to some structural differences among economies, the dilemma facing the Federal Reserve, European Central Bank (ECB), and Bank of England is the same.

Markets and investors receive the same economic news as central bankers, but in addition to dealing with the uncertainty of economic data, markets and investors must also predict what central bankers will do next. They hope that Federal Reserve Chair Jerome Powell will provide some clues at the Jackson Hole Economic Symposium on August 27 about when and how the Fed intends to begin tapering its asset purchase program.

Markets and investors may or may not gain some insight from this symposium. The ongoing public debate between hawks and doves within central banks at least suggests that the current uncertain situation can be interpreted from many different angles.

The Delta variant has further complicated the current situation. Households and businesses currently have conflicting expectations regarding the impact of Delta on the economy, as Powell pointed out in his recent speech: after experiencing the pandemic, it's hard to draw any definitive conclusions.

Perhaps Delta’s impact on economic recovery won’t be so significant because people, businesses, and governments have gained experience in dealing with the virus and have already adjusted their behavior. Moreover, UBS Group Chief Economist Paul Donovan noted, 'Due to the emergence of substantial structural changes, the current statistical data might not fully capture new economic activities.'

Another source of uncertainty comes from government actions. The U.S. Congress is currently discussing a massive stimulus plan that could provide a significant boost to the U.S. economy and even the global economy, but the actual impact depends on the scale and specifics of the plan.

Therefore, as statistical data becomes uncertain or difficult to interpret, it’s no wonder that central bankers have disagreements and use very cautious wording in their respective policy statements.

For now, they still consider this year’s rise in inflation to be temporary. However, U.S. prices have already surged by 5.4% year-on-year. According to forecasts by the Bank of England, UK prices may rise by up to 4% later this year. Inflation in Europe is lower, expected to peak at 2.6% in the fourth quarter, but this is because the Eurozone spent nearly a decade before the outbreak trying to avoid deflation.

Some temporary factors are behind the price increases: energy prices rose sharply in 2020 after falling to a 10-year low during the pandemic; various industries are plagued by supply shortages; consumers who increased savings during the pandemic began significantly increasing spending from the spring of 2021. But now, central banks must assess how long these temporary factors will last.

Central bank governors have all indicated that economic recovery should take precedence. The Federal Reserve and the Bank of England are closely monitoring employment data, while addressing unemployment falls outside the European Central Bank’s mandate. For the Federal Reserve, European Central Bank, and Bank of England, the only certainty is that the large-scale bond-buying programs implemented to combat the pandemic will eventually need to be phased out. But for now, the three major central banks are still searching the data for evidence that economic recovery can be sustained.

By Pierre Briançon, contributing writer for Barron's

Edited by Guo Liqun

Translated by Xiaocai

Original article from Barron's (barronschina). Reprints not permitted without authorization. See the English version in the August 26, 2021 report 'Central Bankers Must Choose: Kill Inflation or Keep the Recovery Alive?'.

(This article is for readers' reference only and does not constitute investment, accounting, legal, or tax advice.)

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