Inflation has risen to multidecade highs in the U.S. and large parts of the world. The reckoning over why it happened and what central bankers should do about it is only beginning.
- That's the takeaway from two speeches delivered Tuesday on opposite sides of the Atlantic, both of which make clear the pressure facing central banks to clean up a mess they helped create.
Why it matters: Even monetary doves have concluded that the economy is at a delicate moment in which high inflation could become entrenched. That has created a new urgency to tighten monetary policy, itself a source of risk for markets and the economy.
Driving the news: Speeches by Federal Reserve governor Lael Brainard and Bank for International Settlements chief Agustín Carstens show that inflation control has become the "paramount" concern of central banks, as Brainard put it.
- Brainard emphasized that high inflation causes more financial distress for lower-income families, and offered a hawkish prescription for Fed action to counter it, including "methodically" raising interest rates and shrinking the Fed's balance sheet "considerably more rapidly" than in the last economic cycle.
- The latter comment fueled a massive bond sell-off, Tuesday, sending interest rates soaring. The 10-year Treasury yield rose 0.14 percentage points to 2.55%, its highest level in three years. (Sorry, prospective homebuyers: That adjustment will quickly flow through to higher mortgage rates.)
Beyond the tactical decisions the Fed and other central banks must make to try to bring demand in line with constrained supply, Carstens warned that the inflation problem may be no short-term blip.
- "We should not expect inflationary pressures to ease soon," said Carstens — head of the Basel, Switzerland-based organization that is essentially the central bank of central banks — at a conference in Geneva. He added that "there are signs of inflation expectations coming unmoored."
- He said that "policymakers may need to shift their mindsets" and that the low-inflation environment gave central banks "great, if not unprecedented, leeway to place more weight on other objectives, be they growth, full employment or others further beyond their traditional remit."
The bottom line: The era of central banks having a free hand to stimulate growth without inflation showing up is long gone. And as Tuesday's market action showed, the adjustment to this new world could be bumpy.
