Central banks in both advanced and emerging economies must step up their efforts to resist a potentially devastating inflationary spiral that has begun to sweep the globe – but such action may come at the price of a hard landing for the world economy, a leading expert has warned.
Bill White, a former chief economist of the Bank for International Settlements, warned that today’s rising prices are a structural phenomenon, resulting from years of ultra-loose monetary policy in the west and exchange rate inflexibility in emerging economies.
He suggested that central banks everywhere are behind the curve in tightening policy – something he said will have severe consequences no matter the policy response.
“The inflationary pressures are already well entrenched and central banks globally are behind the curve,” he told Emerging Markets.
“You have very low interest rates, particularly in the US, and exchange rate resistance elsewhere, leading to an absolute explosion of liquidity globally,” he said.
“This is showing up in increased inflation in emerging markets. But my worry is that it’s also going to feed back to inflation in the advanced economies. We’re already starting to see the beginnings of this.”
White warned that the slow response of monetary authorities – particularly in the US – would mean that interest rates will eventually have to rise sharply.
“If central banks are behind the curve today, they are likely to be even further behind the curve six months or a year down the line, [which will impact] the tightening that they’re going to have to do because it’s belated. My worry is that it would not lead to a smooth landing [for the world economy].
“The tightening must and should come – but with the risk of exacerbating underlying imbalances. But if you don’t do it, what you’re left with is this inflation which will be allowed to rip. [This] in the end will have a similar impact on the imbalances [as would taking action now].”
White said a major concern is whether US inflationary expectations start to come unstuck. They have so far remained low, but White believes they could turn around “pretty quickly”. “It’s a story of rising inflationary pressures everywhere that must eventually be resisted everywhere,” he added.
“When interest rates start to rise in a significant fashion, this will interact with the existing imbalances in the global economy in a way that’s going to make for a very bumpy ride heading downwards.”
His views echoed those of others, including Charles Dallara, managing director of the International Institute of Finance, who told Emerging Markets that US monetary policy continued to pose grave risks for the global economy.
“It is too easy for [Washington] to follow a monetary policy it believes is appropriate for the US itself, but which hasn’t adequately taken into account the global framework in which it operates,” Dallara said.
Fed chairman Ben Bernanke has kept interest rates near zero since December 2008 and is on the verge of ending a bond-buying programme that will add $2.3 trillion in long-term assets the central bank’s balance sheet.
Although inflation has been a major discussion point at the ADB’s annual meeting in Hanoi this week, the emphasis has largely been on how policymakers in the region can tame short-term food and commodity driven inflation. Price pressures, while severe, have been seen to be largely manageable over the medium term.
But White argued that looking at inflation and policymaking with a narrow regional focus is to neglect the interconnected reality of today’s global economy, as well as the sheer scale of liquidity.
“In this global economy, the forces that are driving the inflationary pressures are less and less the direct by-product of what a particular central bank is doing,” he said. “If there were to be a major setback in the advanced economies, particularly in the US, I find it almost impossible to believe that others would come out of this thing untouched.”