No longer "downplaying" the issue! Global central banks refuse to repeat the same mistakes, and under the energy crisis, they may take "strong measures"

Zhitong Caijing APP notes that, at first glance, the Middle East energy crisis is the kind of external shock that central banks should “take the edge off.” But an increasing number of reasons suggest that this time may be very different.

The U.S.-Israel war against Iran that broke out on February 28 has already pushed up Brent crude oil prices by about 50%, reaching $108.50 per barrel, increasing the risk of a surge in global inflation. In theory, central banks should avoid changing policy in response to events like this, unless it is clearly expected that the event will persist, or will keep inflation expectations elevated in the long term.

The Bank for International Settlements (BIS)—an organization committed to promoting financial stability among central banks worldwide—has urged policymakers not to act too hastily, saying the current crisis is a textbook example of how supply shocks should be “played down.”

However, central banks in different countries may not adopt this advice. They still harbor lingering resentment over criticism (whether fair or not) following the 2022 Russia-Ukraine conflict—when they acted too slowly, mistakenly labeling persistently high inflation as “temporary,” only to watch inflation remain above target levels for years.

In addition, the claim that inflation expectations in developed markets are “firmly anchored”—a view long reiterated by central bank governors—now also deserves to be questioned.

In recent years, the world has witnessed a series of “black swan” events that could trigger a structural upward shift in inflation expectations, leading to a spiral of higher prices and increased wage demands.

First was the COVID-19 pandemic—which should have been a once-in-a-century shock—leading to disruptions in supply chains and a surge in demand driven by stimulus policies, causing prices to jump sharply. Immediately following and intensifying this trend was global energy turmoil triggered by the Russia-Ukraine conflict. And now, that conflict has been layered with a new shock: the war in the Middle East.

Against this backdrop, the globalized trade system that has suppressed inflation for decades has been disrupted by the tariff war launched by U.S. President Donald Trump.

Putting all these factors together, policymakers appear unable to sit idly by for the long term—regardless of whether it is a wise move.

Reasons to stay cautious

The Bank of England, the Federal Reserve, and the European Central Bank all kept interest rates unchanged at their recent policy meetings. But there is little sign that they will “take the edge off” the current energy crisis. Instead, their messaging seems intended to convey the opposite message.

Federal Reserve Chair Powell said last month, “We know what inflation has looked like over the past few years, and how a series of shocks has interrupted the progress we have made over time.”

In the minutes of the Bank of England’s March 19 policy meeting, it warned that, “After experiencing consecutive negative supply shocks in the near term, households and firms may be more sensitive to any new inflation shocks.”

On the same day, the ECB also said: “If high energy prices persist, they could lead to more widespread growth in inflation through indirect and second-round effects, and this situation needs to be closely monitored.”

Unless global energy arteries—the Strait of Hormuz—rapidly reopen fully after being blocked by Iran, central banks may feel they have no choice but to take action. But modern history should prompt policymakers to pause and think.

Alan Taylor, an external member of the Bank of England’s Monetary Policy Committee, has recently discussed a thought experiment that he and his colleagues carried out—exploring what would happen if central bank governors starting in 2020 focused only on getting inflation back to target, without considering the knock-on effects on growth.

In his scenario, UK interest rates would exceed 10% in 2023 (rather than the 5.25% peak that was actually reached), and today they would still be around 7%. That would trigger a severe economic recession… while inflation would still reach 7%.

This is only one scenario, but for other reasons, the current situation also needs to be treated with caution.

First, the current starting point for rates is completely different from after the pandemic. Back then, interest rates were near zero, while now the Federal Reserve’s policy rate is 3.5-3.75%, and the Bank of England’s is 3.75%. Both sides say they believe there are some built-in limitations to their respective rates. The ECB has also signaled that it is prepared to raise its key 2% rate to address rising inflation risks.

Watch and communicate

The lesson from the surge in inflation in the post-pandemic era may not be that action needs to be taken faster, but that communication needs to be better. Mistakes were indeed made back then, especially the insistence that the jump in prices was “temporary,” but central banks clearly appear to be more cautious in their forecasts this time.

Both the ECB and the Bank of England have introduced scenario analysis to show how the economy might evolve under different conditions.

In the annual stress-test scenarios released in February, the Federal Reserve’s baseline forecast for inflation is 2.2%, while in its severe adverse scenario (typically simulating a recession caused by demand shocks) it is only 1.0%. If tests were conducted now, these figures would likely be very different.

The ECB’s baseline forecast sees inflation at 2.0% next year, 2.1% in the adverse scenario, and as high as 4.8% in the severe scenario. Only the latter signals the need for rate hikes. The Bank of England will publish the corresponding forecasts by the end of April.

If these scenario analyses are underpinned by firm commitments (that is, achieving the inflation target not “now” but over the medium term), they may help anchor inflation expectations without requiring central bank governors to quickly pull the policy levers.

They should also be wary of an overreaction driven by concerns about credibility. By responding more flexibly to the current situation—rather than trying to correct past mistakes—policymakers can actually enhance their reliability.

As for the Bank of England, David Yackman, Director of the National Institute of Economic and Social Research (NIESR), recently said: “Credibility is not established by making mechanical reactions to data that the central bank cannot control; it is established by clarifying what the central bank can control, what it is paying attention to, and what action it will take if the situation worsens.”

Finally, if central bank governors focus on winning the “last war” rather than addressing the reality of the “current war,” they may face accusations of making major policy mistakes again.

(Editor: Liu Chang)

     【Disclaimer】This article only represents the author’s personal views and is not related to Hexun.com. The Hexun website maintains a neutral stance toward the statements and judgments made in the article, and does not provide any explicit or implicit guarantees regarding the accuracy, reliability, or completeness of the content included. Readers should read for reference only and assume all responsibility themselves. Email: news_center@staff.hexun.com

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