22 Sep 2021
Central banks are likely to fail in taming inflation without better fiscal policy, study says
Introduction
Central banks are in-charge of ensuring economic and financial stability by regulating the supply of money through open market operations. Central banks may see the government under a “sale and repurchase agreement” therefore lessening the amount of money commercial banks have steering short term interest rates in order to impact long term rates and economic activity as a whole. According to an article by Guntram B. Wolff and Gregory Claeys, acceleration of globalization lately has a role in the inflation instability and fiscal policy which are the trade, labour market and the financial integration. The impact of trade integration has led to volatility of domestic price levels affecting international price upsets. Consequently these changes in global prices have a significant impact on domestic prices. A crucial indicator of temporary fluctuations is the energy costs in the eurozone. More notably, in the last two decades there has been an enormous growth in business with inexpensive territories lessening the price of imports. Global rivalry amongst firms and the blending of the worldwide labour market has led to decrease in the ability to control prices by domestic companies and also bargaining power of domestic workers.
Efforts of central banks to manage inflation
Lawmakers at the Jackson Hole conference in the United States showcased that unless the government plays their part with more wise budget policies, central banks will not successfully manage inflation and even lead to higher prices. During the Covid – 19 period governments worldwide had to resort to their coffers to cushion their economies leading to inflation rates to their maximum levels embedding a menace of an expeditious price growth.
Central banks are now raising interest rates to fight inflation but the move was contended at Kansas City Federal Reserve’s Jackson Hole Economic Symposium to not be conclusive in such a situation. Francesco Bianchi of Johns Hopkins University and Leonardo Melosi of the Chicago Fed also noted that fiscal imbalances could lead to higher inflationary duress lest the monetary contraction is inline with the expected results of the fiscal alterations causing acceleration in nominal interest rates, increasing inflation, economic torpor and debt increase that would emerge in such a situation and economic recession would be triggered.
Lucratively with this financial year coming in at $1 trillion, the U.S. budget deficit is determined to be lesser than earlier predicted 3.9% of GDP which is the highest ever and is expected not to decline fully next year. Moreover the euro region is expected to lead in the same direction beginning in the fourth quarter proven by the 3.8% deficiency this year. According to the study the recent occurrence of inflation in the U.S. was as a result of the fiscal policy and lack of confidence in the government to run provident fiscal policies.
Whereas some central banks have been faulted for not spotting the inflation matter early enough although the study contended that even earlier rate increase would have been pointless. Furthermore the More hawkish (Fed) policy would have only reduced 1% of inflation at the expense of 3.4% output less which is too much of a sacrifice.
Conclusion
Monetary and fiscal policy work in diverse ways. But they interrelate since price stability and a stable economy are two sides of the same coin and their interaction matters for the health of the economy. When the economy is not doing well, and interest rates are very low, it is reasonable that monetary and fiscal policy work together to get it back on its feet. When the economy is running efficiently, there is less of a need to work together closely instead of inflating away debt by the government where they would increase taxes or reduce expenditures.
REFERENCES
- Central banks will fail to tame inflation without better fiscal policy, study says By Balazs Koranyi URL: https://www.reuters.com/markets/us/central-banks-will-fail-tame-inflation-without-better-fiscal-policy-study-says-2022-08-27/
- Fiscal and monetary policy in a monetary union by European Central Bank URL: https://www.ecb.europa.eu/home/search/review/html/monetary-fiscal-policies.en.html
- Have central banks lost their ability to control inflation? By Guntram B. Wolff and Gregory Claeys URL: https://www.bruegel.org/blog-post/have-central-banks-lost-their-ability-control-inflation
- Monetary Policy and Central Banking by International Money Fund URL: https://www.imf.org/en/About/Factsheets/Sheets/2016/08/01/16/20/Monetary-Policy-and-Central-Banking