[Summary] Powell and Lagarde Both Say "The Era of Low Interest Rates and Low Inflation Is Over"

On the 29th (local time), at the European Central Bank (ECB) annual forum held in Sintra, Portugal, Andrew Bailey, Governor of the Bank of England (BOE) (from left), Agustin Carstens, General Manager of the Bank for International Settlements (BIS), Christine Lagarde, President of the ECB, and Jerome Powell, Chair of the U.S. Federal Reserve (Fed), attended and spoke.
[Image source=Reuters Yonhap News]

[Asia Economy New York=Special Correspondent Joselgina] "I do not think we will return to a period of low inflation."

Monetary policy leaders of major central banks in the United States, Europe, and the United Kingdom have declared that the era of 'low interest rates and low inflation' has come to an end. With the trend of deglobalization compounded by recent large-scale geopolitical shocks such as the COVID-19 pandemic and the Ukraine crisis, the entire world has now entered a 'new era of inflation,' they warn.

Christine Lagarde, President of the European Central Bank (ECB), stated at the ECB Annual Forum held in Portugal on the 29th (local time), "I do not think we will return to the period of low inflation before COVID-19," adding, "The enormous geopolitical shocks and forces unleashed by the pandemic will change the environment of our economy."

Jerome Powell, Chair of the U.S. Federal Reserve (Fed), who participated in the same session, also diagnosed that the low inflation environment has disappeared, saying, "The economy after the pandemic is operating under different forces than before." He pointed out supply-demand distortions across the economy and supply chain fragmentation due to deglobalization, noting the "changed dynamics" and that "it is difficult to respond with existing monetary policy methods." This implies that monetary policy trends are bound to change drastically. Andrew Bailey, Governor of the Bank of England (BOE), described the post-pandemic economic operation as "a sea change."

The forum took place amid major central banks, including the Fed, pushing or planning high-intensity tightening to curb soaring inflation. The assembled central bank leaders expressed concerns that the inflation shock could become entrenched and reaffirmed their commitment to raising interest rates.

◆"No Return to Pre-Pandemic Times"

The message delivered by the heads of major central banks, tasked with curbing soaring inflation without causing a recession, concluded that the global economy has now entered a 'new era' based on high inflation. Central bank monetary policies must inevitably change in response to the rapidly shifting economic dynamics after the pandemic.

The reason for the deepening concerns among central bank governors stems from the significant changes in factors affecting the global economy compared to before the pandemic. This is why Powell, Lagarde, and Bailey, gathered in one place, unanimously stated, "The era of low inflation will not return" and "We cannot go back to pre-pandemic times."

Countries that have grown together based on globalization over the past 30 years are now divided into competing blocks amid the trend of deglobalization. Supply chains are fragmented, productivity is declining, and various costs are inevitably rising. The sudden COVID-19 pandemic played a role in instantly collapsing the global supply chain system. Inflationary pressures intensified further following Russia's invasion of Ukraine in February.

Powell assessed that these changes in dynamics are even altering the Fed's role, which has aimed for 'price stability' and 'maximum employment.' He explained that this will inevitably have a significant impact on the policy stance of central banks worldwide.

He said, "The past decade was the peak of deflationary factors. Currently, at least for the time being, those factors seem to have disappeared," adding, "We are in a completely different new world with higher inflation, many supply shocks, and strong global inflationary pressures." Accordingly, he emphasized, "Monetary policy must be approached in a very different way." Powell admitted that forecasting inflation in this environment has become a much more difficult task and acknowledged, "Only now do we better understand how little we know about inflation."

Lagarde also hinted at the need for changes in future central bank policy directions. She said, "Continuous efforts are necessary to achieve inflation targets," while pointing out, "Fiscal and monetary policy coordination is not as effective as it used to be."

Many countries are commonly experiencing soaring inflation, growing concerns about economic slowdown, and shocks from surging energy prices. Augustin Carstens, General Manager of the Bank for International Settlements (BIS), said, "Situations differ by country," but evaluated, "Everyone's goal is to control inflation."

◇Powell: "The Bigger Mistake Is Failing to Control Inflation"

There is also a strong sense of crisis that high inflation could become entrenched. This is the part that major central bank leaders worry about most. The reason the Fed and others have recently warned of a recession yet still announced high-intensity tightening is precisely this.

The Fed, which has taken on the role of inflation fighter, raised interest rates by 0.75 percentage points this month and has announced plans to raise rates by 0.5 or 0.75 percentage points next month. The BOE has already implemented five consecutive rate hikes. The ECB has announced its first rate hike in 11 years at the July meeting.

At the forum, Powell said that while rapid rate hikes could pose economic risks, the bigger mistake would be failing to control soaring inflation. He stated, "Is there a risk that (tightening) goes too far? Of course, there is a risk," but emphasized, "I do not agree that (excessive tightening) is the biggest economic risk. The bigger mistake is failing to restore price stability." This message implies that the risk of recession must be accepted to achieve the top policy goal of price stability.

Powell also mentioned the multiplicity of shocks that can occur in a high inflation regime, saying, "Our mission is to prevent this." He added that suppressing long-term inflation expectations is also important, explaining that this prevents inflation expectations from becoming entrenched and creating a 'self-fulfilling cycle.'

Lagarde reaffirmed the ECB's prior announcement to raise rates in July and September. While emphasizing a "gradual direction," she stressed, "We will respond more swiftly if necessary." BOE Governor Bailey said, "The global economic shock is significant. The UK has also been hit," but added, "If inflation persists longer, we will respond more strongly." Bloomberg News evaluated, "Central bank leaders have now acknowledged how much the world has changed."