The last time UK inflation was as high as it is now the British pound was linked to the now-defunct Deutschmark. In the US, the rate of price growth is the highest since 1982, which economic historians see as roughly the end of the 1970s “Great Inflation”. Eurozone inflation, meanwhile, is the highest it has been in the currency bloc’s history — unsurprising, perhaps, given soaring natural gas prices and the spectre of an inflationary war in Europe. Only Asia seems immune from the pressures.
It is clear that emergency stimulus is no longer required for economies with tight labour markets and high inflation. Yet central banks face hard choices over how fast and far to raise rates. Move too early and they risk choking off growth, while doing nothing to counter cost pressures that are more to do with Covid-related bottlenecks and geopolitical tensions. Move too late and an even more aggressive approach may be required to tame inflation.
The worry for central bankers is a “wage-price spiral” as workers attempt to shield their take-home pay from the effects of higher prices. A tight labour market, fuelled by cheap money, could cause rising inflation to feed off itself. Workers, aware that vacancies are at a record high in many advanced economies, might sensibly try to ensure their pay packets keep pace with prices (though there are some questions about whether workers in modern, deregulated labour markets have the clout to negotiate wage rises that keep up with inflation). Any wage gains, however, would be illusory and quickly fade as they, in turn, sparked higher inflation.
Combating a wage-price spiral moves central banks into controversial territory. Andrew Bailey, the governor of the Bank of England, attracted a widespread backlash for comments that workers should exercise pay restraint. One tabloid went so far as to label him the “Plank of England” on its front page along with a reference to his high salary. But while Bailey’s words were clumsy, it is the job of a central banker to play “bad cop” when required. Unelected technocrats do not need to be liked.
A bigger concern than the public relations issue is that tightening too fast will bring about the very situation central bankers wish to combat. Since the 1980s, some economists have argued that, in the long run, monetary stimulus can only lead to inflation, not real income growth — necessitating that central bankers should be conservative and, in the interests of workers as well as everyone else, overly sensitive to the inflationary risks from rising labour costs.
A growing contingent of economists, however, argue it is precisely this conservatism that has led to multiple decades of meagre wage growth. Focusing excessively on inflation can lead to a permanent loss of economic output and productivity, scarring the economy. In the US, the pattern of higher nominal wage growth — especially for lower income households — could end. Not only could this be bad for workers, it would also cut off the demand necessary to convince businesses to invest more. To top it off, the supply problems that led to inflation in the first place may remain.
These are the most difficult monetary policy decisions central bankers have faced since the early 1980s. That makes effective communication, and avoiding Bailey’s “foot-in-mouth” comments, vital. Workers, just as much as companies, are right to act in their own interests and pursue the best deals they can. Central bankers, however, must make it clear that monetary policy will tighten and they will always pursue a 2 per cent norm for inflation; workers should similarly expect central banks to do their best too.