Reining it in The immediate pandemic-induced crisis may be over, but the landscape emerging in its wake poses plenty of challenges for policymakers. Global inflation is rising. Global growth is slowing. The battle against COVID-19 is far from won. Despite the uncertainties, many central banks want to bring the era of ultra-loose monetary policy to an end. After all, economies have rebounded and employment numbers are much better than feared early last year. At the FOMC’s September meeting Federal Reserve Chair Jerome Powell confirmed that the taper test was “all but met” so, barring a big negative setback, the US will start to reduce its asset purchases in November. Meanwhile the Bank of England has even said it could raise rates before halting QE. Monetary stimulus will wane just as many governments, their deficits bloated by pandemic-fighting measures, are cutting support too.

Slowing growth The initial burst of activity linked to reopening is over, and growth momentum is rapidly losing pace.

Fading fiscal support is playing a role but so too are the direct impact of COVID-19 related restrictions and disruptions. In parts of Asia, like Malaysia, lockdowns have shuttered factories, causing further disruption to global supply chains, but in China the robust export performance suggests much less disruption to the supply side. However, the restrictions in China have had a significant impact on local economic activity which is already being constrained by the regulatory tightening to the property sector in particular. Any further weakness there would hurt commodity producers in emerging countries, many of which are already feeling the impact of domestic tightening and could be further hit as US monetary support becomes less accommodative. Meanwhile in the advanced economies, where vaccines have been more abundant, some cross-border travel restrictions are being eased. But there are signs of consumer confidence faltering as case numbers stay elevated and inflation keeps rising on the back of a growing array of supply shortages.

Supply bottlenecks and inflation risks Widespread supply bottlenecks are inevitably raising prices and squeezing disposable incomes and there is currently little hope of inflation rolling over quickly. In Europe the recent surge in wholesale gas prices could even lead to another leap in inflation in the first half of 2022. Some of this strength should be temporary – used car prices and ‘reopening effects’ in hospitality are unlikely to keep inflation high in two years’ time. Inflation could still prove to be “transitory”. The longer it stays high though, the greater the risk of a wage response, especially if labour market mismatches persist.

There are other reasons why higher inflation could be a bigger danger over the medium term than it has been for a long time. Inflation uncertainty has undoubtedly risen. Most of the upside risks to medium-term inflation stem from fundamental changes in political economy. Central bankers are no longer required single-mindedly to pursue price stability above all else: they also have to worry about growth, employment, financial stability and even climate change, raising the risk of policy conflicts and therefore policy error in both directions. Quantitative easing may have increased the risks of fiscal dominance returning through the “back door”, not least given the huge increases in government debt witnessed both before and during the pandemic. At the same time, reverses in globalisation – reflecting both deteriorating relations between China and the West and, more recently, pandemic-related cross border restrictions – also pose upside risks.