Central banks do not have the luxury of time in tackling inflation

The writer is a senior fellow at Harvard Kennedy School

It is hard not to pity those who must produce a macroeconomic outlook for 2022. The paths of growth and inflation were already uncertain, and now there is the added unknown of the new coronavirus variant, Omicron. The chief executive of Moderna told the FT that existing vaccines are likely to be much less effective at tackling Omicron. The chief executive of BioNTech is more sanguine and expects fully vaccinated people will face only moderate illness. The World Health Organization says it’s possible the variant will be much more transmissible, but concurs that vaccines should protect against severe cases. And those are the experts.

With time, we’ll know the answers. But the central bankers who meet this month don’t have the luxury of time. The US Federal Reserve meets on December 14-15, the Bank of England and the European Central Bank on December 16. Will Omicron be a drag on demand that requires stimulus? Or a further boost to inflation that requires tighter monetary policy?

The best case is for Omicron to be so transmissible it becomes dominant, but causes only mild cases with no long-term effects — evolving into a version of the seasonal flu. Another good outcome would be that vaccines remain extremely effective and there are few breakthrough cases, which are moderate. In either scenario, the central bankers’ base case — that inflation will peak next year as supply chain disruptions abate — will probably prove correct.

Yet if the variant is transmissible enough to become dominant, causes severe illness and can circumvent vaccines, the impact on global economies is certain to be strong, if unclear. People may again stop going in to work. According to an August survey by The Conference Board, fear of contracting Covid and fear of exposing a family member were respondents’ biggest concerns about returning to the workplace. And this against a backdrop of freely available, highly effective vaccines.

If workers stay at home because of the new variant, supply chain disruptions would be exacerbated and prices could rise even faster, a consequence Fed Chair Jay Powell highlighted in congressional testimony this week.

Yet the negative scenario could also result in much slower price increases. Even without a new variant, the surge in demand experienced on reopening the economy is expected to ease. Real incomes and personal savings have already reverted to pre-pandemic trend. Add to this a deadly virus against which we have little to no protection, and there’s a strong likelihood people would stop going out and spending money just as supply begins to increase next year.

Leaders in the US and Europe have vowed not to impose new lockdowns. But some may feel they have no choice. Austria imposed a temporary lockdown before the Omicron variant emerged in order to address an outbreak of the Delta variant. German hospitals already had a record caseload of Delta before Omicron showed up.

Demand could crater even without lockdowns. According to research conducted by Austan Goolsbee and Chad Syverson of the University of Chicago, a collapse in US travel in the spring and winter of 2020 resulted more from voluntary behaviour changes than from government-mandated lockdowns.

Given accelerating inflation in Europe and the US, it’s unlikely central banks will put the stimulus pedal to the metal again. But will the variant temper their plans to slowly withdraw accommodation? Even in the face of a collapse in demand, monetary policy kicks in with huge lags, and a vaccine can be adapted for new variants in a matter of months.

Omicron will not bring us all the way back to the uncertainty of March 2020. But it is a warning that however this variant shakes out, other mutations will almost certainly follow. You don’t really have to pity the central bankers, but maybe cut them some slack.