Analysis: The pain of inflation crushing will reverberate across the globe

JACKSON HOLE, Wyo., Aug 29 (Reuters) – The message from the world’s top finance leaders is loud and clear: rampant inflation will persist and taming it will require extraordinary efforts, most likely a recession with job losses and shockwaves across emerging economies.

However, this price is still worth paying. Central banks have spent decades building their credibility on their ability to fight inflation, and losing that fight could shake the foundations of modern monetary policy.

“To regain and keep confidence, we need to bring inflation back to target levels quickly,” said Isabel Schnabel, Executive Board Member of the European Central Bank. “The longer inflation remains high, the greater the risk that the public will lose confidence in our determination and ability to maintain purchasing power.”

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Banks should continue even when growth suffers and people start losing their jobs.

“Even if we enter a recession, we basically have no choice but to continue on our political course,” said Schnabel. “If inflation expectations were to be unanchored, the impact on the economy would be even worse.”

Inflation is in the double digits in many of the world’s largest economies, levels not seen in nearly half a century. With the notable exception of the United States, a peak is months away.

To make matters worse, central banks seem to have limited control most of the time.

First, high energy prices, a consequence of Russia’s war in Ukraine, are creating a supply shock over which monetary policy has little impact.

Excessive government spending, even outside of central bank control, exacerbates the problem. A study presented in Jackson Hole argues that half of US inflation is fiscal and the Fed cannot control prices without government cooperation. Continue reading

Eventually, a new inflationary regime could kick in that will keep prices under upward pressure for an extended period of time.

Deglobalisation, the realignment of alliances due to the war in Russia, demographic changes and more expensive production in emerging markets could make the supply shortages more permanent. Continue reading

“The global economy appears to be on the cusp of historic change, as many of the tailwinds in aggregate supply that have been keeping inflation in check will turn into headwinds,” said Agustín Carstens, head of the Bank for International Settlements.

“If so, the recent spike in inflationary pressures could prove more persistent,” said Carstens, who heads a group often dubbed the Central Bank of the World’s Central Banks.

All of this points to rapid rate hikes led by the Fed, with the ECB now trying to catch up, and high interest rates for years to come.


The pain of high US interest rates will resonate well beyond the country’s economy, hitting emerging markets hard, especially if high interest rates prove to be as sustainable as Powell is now signaling.

“Now is crisis time for the Fed,” said Peter Blair Henry, professor emeritus and dean of New York University’s Stern School of Business.

“The credibility of the last 40 years is at stake, so they will cut inflation at all costs, even if it means collateral damage in emerging markets.”

Many emerging markets are borrowing in dollars and higher Fed rates are hitting them on multiple fronts.

It drives up the cost of borrowing and raises questions about debt sustainability. It also funnels liquidity into US markets, pushing up emerging market risk premia, making borrowing even more difficult.

Eventually, the dollar will continue to strengthen against most currencies, driving up imported inflation in emerging markets.

Larger countries like China and India appear to be well insulated, but a host of smaller countries from Turkey to Argentina are clearly suffering.

“We have a number of particularly border economies and low-income countries whose spreads have risen to what we call distress or near distress, which is 700 basis points to 1000 basis points,” said IMF Chief Economist Pierre-Olivier Gourinchas.

“There’s a large number of countries, it’s about 60% of low-income countries, we have about 20 emerging and frontier countries that are in a situation,” he said. “They still have market access, but certainly credit conditions have deteriorated a lot.”

A monitor from S&P Global now rates the refinancing risk of lenders in South Africa, Argentina and Turkey as high or very high. She also sees the credit risk of financial firms as high or extremely high in a variety of countries, including China, India and Indonesia.

“There are a few border countries like Sri Lanka, Turkey and so on that will come under pressure if the Fed hikes rates and rates stay high,” said Eswar Prasad, an economics professor at Cornell University.

“A two to three year horizon will make things difficult… If it becomes clear that the Fed will keep rates high for a long time, the pressure could hit immediately,” Prasad added.

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Additional reporting by Ann Saphir; Adaptation by Dan Burns and Chizu Nomiyama

Our standards: The Thomson Reuters Trust Principles.

Howard Schneider

Thomson Reuters

Covers the Federal Reserve, Monetary Policy and Economics, University of Maryland and Johns Hopkins University graduate with previous experience as a foreign correspondent, economic reporter and local contributor to the Washington Post.

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