Major economies struggle with explosive inflation rates, but the crisis also highlights policymakers’ failure to determine the degree to which price pressures are rising.
And the question is, how did the major central banks continue to make mistakes despite record amounts of monetary and fiscal stimulus?
Most Fed rate-setters failed to anticipate higher inflation. They overestimated the speed of its decline, while economists at the Bank of England and the European Central Bank underestimated inflation and its durability.
Poor expectations around the world have also contributed to the failure of the central bankers to perform their key function of maintaining price stability.
Failure to set inflation rates left central bankers no room to risk financial instability by having to raise interest rates much faster than usual, as well as threatening the credibility of institutions that depent on trust to steer the economy toward sustainable growth. The Financial Times reported.
HSBC’s Chief Economic Adviser, Stephen King, blames their collective failure on interest rate-setters who rely heavily on their ability to control public expectations of what will happen to prices in the future.
In normal times, the rules governing firms’ pricing decisions and workers’ demands for higher wages could be affected by central bankers’ inflation targets of around 2%.
But what predictions failed to show is that these rules apply only when inflation is generally stable.
Once price pressures rise, and continue to rise, citizens begin to believe that « the central bank is now talking nonsense, » and uncertainty abounds. Recent inflation readings are more important than central banks insisting that their policies can put down price pressures.
The blow to central banks’ reputations was due to their failure to predict inflation and forced those banks to raise interest rates aggressively, up to 75 basis points, in order to convince investors and the public of their commitment to keep inflation low.
In some quarters, this has also led to soul-searching, with the ECB issuing a report on its mistakes in reducing inflation rates, promising to focus more on underlying inflation rather than predicting future models.
IMF has also spoken publicly about its expectations of « miscalculation », although this has not been reflected in any of its flagship reports.
The Bank of England was more combative, arguing that its mistakes did not owe much to errors in expectations and that the mistakes were the results of major shocks such as the war in Ukraine, which could not have been predicted.
While other institutions have been less defensive, economists elsewhere have warned that the public should focus less on whether or not expectations are correct.
But they argue that this is impossible and the public should focus more on whether the outlook says something insightful about the economy at this point.
Failure to predict major economic trends does not mean that forecasters were ignorant, even if it turned out to be incorrect, officials and ministers still felt that the Fund’s expectations were useful because they gave a sense of scale and explained the possible ripple effects of global trends. Daniel Lee, who heads the team that produces the IMF’s Global Economic Outlook Report, said.
He pointed out that « the priority is to give decision-makers an idea of what to expect, as well as the risks so that they can take the necessary steps. »
Others, however, are less sympathetic. Mohamed El-Erian, an advisor at Allianz, said the Fed’s prediction that higher inflation rates would be « temporary » was « one of the worst in decades, » noting that the Fed could have detected the extent of inflation. The severity of inflation advances if he closely examines the evidence from the companies and the implications of his actions.
Central banks, especially in the United States, have made significant prediction errors « unilaterally » without acknowledging them, and such errors can be blamed on models that « failed to keep pace with significant structural change in the economy. »