Advertisement

Macroscope | The US Federal Reserve and other central banks must be proactive on inflation, but not overreact

  • In favouring shock therapy to contain inflation, the Fed and other central banks that appear to be following suit on tougher policies risk a harder landing for their economies
  • Should central banks act with impunity and expect governments and taxpayers to pick up the tab for all the damage wrought by recession?

Reading Time:3 minutes
Why you can trust SCMP
2
A cyclist passes a Metro green line light rail train wrapped with a “Beat Inflation” advertisement for the 99 Cents Only Stores in Redondo Beach, California, on August 31. Photo: AFP
Central banks have the bit between their teeth to take down inflation. Later this week, the US Federal Reserve looks set to announce another steep 0.75 percentage-point interest rate rise, the same as at the past two monetary policy meetings, in June and July.
Advertisement
Clearly, the Fed favours shock therapy to contain inflation and, in doing so, risks a harder landing for the US economy. The Fed is not alone, as the European Central Bank and Bank of England both appear to be following suit with tougher policy responses.

But, is it their remit to push economic activity back into recession, with its implied toll on business output and employment? Should central banks act with impunity and expect governments and taxpayers to pick up the tab for all the damage wrought by recession? It may be time for central banks to have a heart and avoid policy overkill, for the sake of global welfare.

The current global inflation spike is a supply-side shock, mainly caused by post-Covid-19 supply-chain issues and the Ukraine war. Global growth prospects can ill-afford another needless squeeze on supposedly non-existent demand-pull inflation risks. The US is already in technical recession after two successive quarters of negative growth and there is little that Fed policy can do to change two exogenous factors which are outside its control.

Of course, the Fed is deeply rattled about core inflation jumping to 6.3 per cent in August from 5.9 per cent in July, despite the headline consumer price inflation rate easing to 8.3 per cent, from 8.5 per cent, over the two-month period. The Fed must be proactive, but it shouldn’t overreact.

Advertisement

The worry for the Fed is that elevated inflation perceptions are becoming embedded in a psychology of rising prices, which could easily turn into a vicious wage-inflation spiral.

Advertisement