The underestimation of new wave of inflation, well above 8% in the USA and in Europe, with effects yet to be fully shown on final prices in many segments, involved the monetary authorities of half the world at all levels. Transient, passing by, persistent but destined to be absorbed, up to the latest forecasts which see inflation well beyond the set targets for a long time. «Central banks have probably underestimated the inflation dynamics. They also had to deal with unexpected shocks, most recently the war which contributed to heating up energy and raw material prices even more,” he notes. Pierpaolo Benigno, Professor of Monetary Macroeconomics at the University of Bern and EIEF Research Fellow.
Almost all of the monetary authorities' forecasts of inflation have turned out to be wrong.
«The United States and the European Union have underestimated the impact of policies to support the economy during the pandemic. The effects of supply-side bottlenecks in value chains have also been largely underestimated.
Why?
“Econometric models fail to “capture” such large-scale impromptu shocks. The question of the failure to forecast the stimulus effects deriving from the increase in aggregate demand is a different matter».
Having acknowledged the undervaluation, are you convinced by the Fed's aggressive strategy?
«In the USA there is a very “tight” labor market, it is difficult to find available workers. In a situation of strong wage pressures and high energy costs, there is no other way than an aggressive monetary policy. Even if we break down the various parts of inflation, the medium-term forecast would still be high. Bear in mind that with inflation at 8% and rates expected for 2023 of around 3%, technically we are in economies with real rates that are still negative. It's a theoretical puzzle."
How is this puzzle composed?
“Where is the equilibrium real rate? That's the big question."
In the new European balance of power, who in the ECB will govern this choice? France or Germany?
«Jens Weidmann has long been the German voice of monetary policy in Europe, today European policy is being redefined. Lagarde said the ECB stands ready to create new tools if needed. But with inflation in Germany at levels never seen before and with the negative effects of the war still to be revealed, the picture remains very complex».
The fact is that the ECB is more wait-and-see than the Fed.
“If stagnation arrives in Europe, there could be natural effects of containing inflationary pressures. This is why in Frankfurt they are very careful to evaluate the trade-off between the "cure" of inflation and the deceleration of growth. We will have to see what happens also in the field of wage negotiations».
The trade unions do not seem to be particularly pushing on this point. What will happen to European consumption?
«The ECB has a precise mandate, that of price stability. The labor market in Europe is not as "tight" as that of the USA, certainly if there were strong unions the push to review negotiations would have already begun".
Are the markets still convinced in their expectations of central bank strength?
«In these 15 years of crisis, monetary policy has proved to be a strong tool, even if the direct channel between rates and inflation has broken down a bit. I reiterate the big question: Western central banks have to deal with a natural real rate that has fallen in recent years. For many reasons, starting also from the demographic question. We have seen seasons with inflation at 2% and rates at 4%, what would happen if we did it now? Today monetary policy governs the economy with inflation at 7-8% per cent and rates that are still close to zero and it is expected that they will at most settle at 2-3%».
Had globalization also made individual monetary policies more difficult to convey?
«It did so by dramatically increasing the competitive effects on the commodity and financial markets. Today we are going back, we are witnessing a process of partial de-globalization and regionalization. The reorganization of the value chains, with the reshoring from Asia, will in any case have effects on the prices of the goods still to be weighted».
