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Inflation: can central banks tame it? Hear the Radio Davos podcast

Inflation on his mind: Federal Reserve Board Chairman Jerome Powell

Inflation on his mind: Federal Reserve Board Chairman Jerome Powell Image: REUTERS/Elizabeth Frantz

Robin Pomeroy
Podcast Editor, World Economic Forum
Abhinav Chugh
Content and Partnerships Lead, World Economic Forum
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  • Central banks and putting up interest rates, but will that succeed in reining in inflation?
  • Sandra Phlippen, Chief Economist at ABN AMRO and Erik Peterson of Kearney explain the tough choices facing policy-makers.
  • Subscribe to the podcast: Radio Davos.

Inflation is a major concern for economic policymakers around the world - for companies and for all of us who are seeing prices rise faster than our incomes.

On this episode of Radio Davos, we hear from two experts: Sandra Phlippen, Chief Economist at ABN AMRO bank, and Erik Peterson, partner and managing director at the consultancy Kearney.

They were speaking on Our World in Transformation, a video show, hosted by Abhinav Chugh, that the World Economic Forum's Strategic Intelligence platform puts out to the World Economic Forum’s digital members every two weeks. You can sign up at the website www.weforum.org/join-us.

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Transcript

This transcript has been generated using speech recognition software and may contain errors. Please check its accuracy against the audio.

Abhinav Chugh, World Economic Forum: I just want to start the conversation by a question which is on everybody's mind right now. Are we going to go under 2% inflation in 2023 or not? Let's let me start with you, Sandra. What is the what does the forecast look like?

Sandra Phlippen, Chief Economist, ABN AMRO: We think not. Well, it depends on I mean, where we end in 2023. It depends on which geographic area we're talking about. But I don't think there will be maybe any place where we get to the 2%. No.

That's said, actually, we should realise that the 2% target so being on 2% or close to 2% is not something that that needs to be achieved in the immediate run. So if you're talking about the inflation targets of the ECB and the Fed, those are longer term targets and not immediate targets. So I think that is an important nuance here.

Abhinav Chugh: Thank you, Sandra. Erik, I wanted to ask you how successful have interest rates been in tackling inflation? It's been used many times in the past as a as a tool. But are we ready, is it going to work again this time?

Erik Peterson Partner and Managing Director, Kearney: Well, the story is playing itself out in terms of how interest rates are tackling inflation. But one thing is crystal clear. We have a long way to go from where we are now. Global inflation, as we all know, is extremely high. As you mentioned, we have it at 7.7 [percent] range projected for this year, a corresponding level for the G7 countries of about 7%. Now the good news is that interest rates are pushing it down now. It is declining, although quite unevenly, as Sandra said. But we think it could fall probably to the 3% range by the end of 2023. But in my view, I agree with Sandra. I think 2% is out of the cards, at least for next year.

And all that, of course, assumes that we don't encounter unexpected circumstances that serve to increase inflation. We got a painful reminder of that at the beginning of this year that that is a very risky assumption indeed.

Abhinav Chugh: Until recently, a lot of factors relating to inflation were were attributed to more more temporary factors, such as like the COVID 19 lockdowns, supply chain disruptions and production constraints. Now, the story seems to be something different. What are what are some of the underlying factors that we're not paying enough attention to that we should be talking about more now? Sandra, would you like to start on this one?

Sandra Phlippen: That is a very important question, actually. So I think that, of course, we had inflation before the war between Russia and Ukraine started. But what has happened since then is is an energy crisis. And that was, of course, primarily driven by the war and the shortage of Russian gas flows, at least for the European continent that is that is the main thing.

And then two other factors that are getting less attention. They're not that big. But but I don't think we should underestimate them either is at least speaking for Europe again for a moment. So, one, the continuing commitment to the Paris agreement. So that means an energy transition where we have decided in Europe to not consider all alternatives and keep on that path. And that is actually increasing the squeeze.

Without large scale intervention here, we are going to face the biggest fall in real incomes that we have seen in decades.

Sandra Phlippen, Chief Economist, ABN AMRO

And the third element that is actually just I mean, I don't think it's been systematically brought together yet. But what we're seeing, at least over the course of the last summer, is that there's heat and drought going on, which is basically decreasing water levels and generating shortages in electricity from Norway. There is lower river, lower water levels in rivers, preventing important energy commodities to reach their destination to generate energy. And there is warming water as well, which is basically leading to nuclear power plants to operate below capacity.

And those are all factors that are now playing. So we're kind of reaching a perfect storm in a way. And I think that without large scale intervention here, we are going to face the biggest fall in real incomes that we have seen in decades.

And on top of that, there will be industry output losses from either the margin squeeze from these prices or from rationing, which could be government induced. So that is without any intervention. So we are already seeing, of course, from the monetary side, a large intervention. So the Fed is likely to to tighten significantly further while inflation risks are to the upside.

ECB is following suit, but I think we should realise that Europe is both having the tightening impact from the ECB's actions but also tightening from the spill-overs of the US tightening. And this is pushing bond yields up and equity markets down. And ultimately all this will dampen growth, we think, into a potentially deep recession in Europe and also recession in the US.

Abhinav Chugh: But when you talk about a large scale intervention that is required at this point, is that related to converting the shock that we're facing right now in terms of energy supply and prices into more of an opportunity towards alternative investments? Or are there other large scale interventions that could have greater impact?

Sandra Phlippen: I think the first thing to state here is that the we should be aware of, at least for the ECB, which is very different than the Fed, because the Fed is basically fighting home-grown inflation while the ECB is fighting mainly imported inflation.

So from the ECB side, a lot of the counterweight and the intervention needs to come from fiscal support. And if you think about the fiscal task, it's also a very daunting one, because on the one hand, you need to prevent poverty, massive scale poverty from energy bills that just can't be can be paid anymore.

You want to soften the blow to consumption from the spill-overs of those higher energy bills and consumption in general, which is, of course, lowering growth. But at the same time, you need to destroy demand in order to tackle this inflation, because this is not a price rise that is driven solely by risk pricing. This is an actual real shortage problem. And the shortage problem can't be tackled if you don't destroy demand. And there's the painful trade-off of policymakers that they need to face basically at this point in time.

The compensation [to help people cope with rising prices] needs to be a compensation for increasing costs, and we should avoid to create additional spending power. This sounds very contradictory, but this is exactly the policy dilemma that is that is on the ground in Europe.

Sandra Phlippen, Chief Economist, ABN AMRO

So that dilemma basically generates the risks of providing policy instruments which provide large compensations, hopefully lump sums and not tax reduction, because you destroy the incentive for demand destruction. But let's say if the governments decide for for lump sum transfers and the problem is that if you tackle that and you reach the wrong people, basically the people who still have a large COVID savings in their bank accounts and are still, we see from our payments data, are still not tapping into their savings, and you start transferring money to them at the wrong point in time when the energy bill has not really fully come through into eroding purchasing power.

Then you basically also run the risk of increasing the inflationary problem because basically you incentivise people to spend more while you need to destroy this demand.

So the compensation needs to be a compensation for increasing costs, and we should avoid to create additional spending power. And this sounds, this is very contradictory, but this is exactly the policy dilemma that is that is on the ground in Europe.

Abhinav Chugh: Yes, I absolutely agree that there's a big debate on the policy dilemma over over, you mentioned. tax cuts as an instrument. I'm curious to hear your thoughts on this, Erik, as well. Is cutting taxes a sustainable solution over here?

I don't think cutting taxes is a long term solution when it comes to preventing rises in inflation ... In fact cutting taxes may actually increase consumer disposable income, lead to rises in demand for goods and services and could serve to even drive up inflation when we least want to see it.

Erik Peterson partner and managing director, Kearney

Erik Peterson: I don't think cutting taxes is a long term solution when it comes to preventing rises in inflation. The idea is that the need for a disinflationary overall macroeconomic stance, which is really hard to achieve and has the contradictions embedded in it that Sandra has just mentioned, is difficult to achieve with either decreased taxes or significant spending on government side. A double edged sword, in my view.

In fact, cutting taxes may actually increase consumer disposable income and lead to rises in demand for goods and services. And could that could serve to even drive up inflation when we least want to see it.

There's some interesting case studies on this under way here in the US right now. Some of our states have proposed and implemented tax cuts in an effort to tame inflation, including Florida, which has done tax holidays on sales of certain consumer products. Iowa, personal and corporate tax. In Virginia, gas tax holidays. And while it may be politically attractive to offer constituents tax breaks, this is generally shown to have inflationary trends to drive up consumption.

So in the end, I think we need to come at this problem from both sides: supply and demand side - that includes boosting supply of key goods and services. Gasoline and food obviously are in the cards for all the reasons that we've talked about. And this also brings us to a discussion, I think, on the globalisation track which is influencing the degree to which tax cuts and other national policy issues can be put into place.

Abhinav Chugh: Yes. Talking about that globalisation drug, let's take into account some of the geoeconomic threats that are fuelling this as well. I mean, we've had supply chain disruptions and and a war at this point, but this doesn't seem to be ending anytime soon. There's there's a lot of statements being made about now we're entering a period of a lot of volatility and the great moderation is over. Is there some kind of rethinking taking place for monetary policy as we enter this new volatile era, Sandra?

Sandra Phlippen: If you think about the globalisation dilemma, since COVID we had massive supply chain disruptions which were actually the prime reason for supply chains not keeping up with the excess of demand from from reopening after COVID. That was the problem that we used to be concerned about before before the war.

And actually two things are happening since then: one element that basically made the problem worse, there is a structural realignment going on in those basic commodities since since the war started. And that will find a new equilibrium at some point. But that can take time. And I think that we have for a long time been thinking that, you know, this globalisation was already slow realisation but it was not yet deglobalisation and you know, there were many people already predicting that that would happen at earlier point in time. We haven't seen it up until now, but we think that the war might be kind of the last shift in this direction, which might turn, turn this globalisation stream.

However, that said, it is also a matter of just new equilibriums that that that will emerge. So that is in a sense also price increasing making matters worse.

But there's also the other side and that is that we have constructed a global supply bottleneck indicator from kind of a collated set of existing supply indicators have been weighed in various ways. And basically that has been very helpful to keep track of where global supply disruptions are. And what we're currently seeing is that that is the one silver lining actually, that this energy crisis that we see at least from from the commodity prices side, price pressures from global supply are really going down.

So of course, the worries are what's going to happen to China. And our growth projections are already at 2% below China's official targets. So that is not looking well. And there are there are many concerns on the Chinese economy, but for at least at this point in time, we see that this bottleneck indicator is going in the right direction. So that is that is one silver lining I would add here.

Abhinav Chugh: Thank you. And let's talk about the cost of living crisis a bit more and the impacts of this as well. Erik perhaps, I would be curious to hear your insights on this as well. Is there a role for central bankers to play in in constraining the crisei that we're going deeper and deeper into here?

Really extraordinary that we've moved from quantitative easing and low and negative interest rates to where we are now; no spectre of inflation to the very high inflationary drag that we have on the economy right now.

Erik Peterson partner and managing director, Kearney

Erik Peterson: Yeah. Let me kick off Sandra, and then I'd be interested to hear your comments as well.

I believe that central bankers have a critical role to play right now, and where things are going, Really quite amazing for us to take stock right now in terms of where we were prior to the pandemic then the rigours of the pandemic itself and then the turbulence, the circumstances that in Jackson Hole they called the onset of a period of great volatility that have started right now. Really extraordinary that we've moved from quantitative easing and low and negative interest rates to where we are now, no spectre of inflation to the very high inflationary drag that we have on the economy right now. And then the geopolitical churn that we see that's contributing to all of the above certainly has become more pronounced.

So as we think about it from that context, then the operative question becomes how are central banks rethinking this great turbulence, this great volatility? And my guess is that they'll rely on traditional instruments, they'll crank up interest rates, look for other ways to reduce economic growth. And that, of course, engenders all of the significant trade-offs with respect to the lives of all the people who are subject to those interest rates and being affected by inflation going forward.

And then one last point. I think that inflation now is kind of spreading out, and we need to be thinking about some of the issues that existed way back when, in the 1960s and 70s, when perceptual inflation was something that was a very, very significant obstacle. And we really can't afford now not to have gone through these significant macroeconomic and policy shifts to address the threat of inflation without trying to put it out or put it back in its place in the longer term.

Sandra Phlippen: If I just may pick up where we're at, where Erik is going there. I think this is yet another very interesting discussion. To be frank, I don't I'm not sure yet what imbalance the outcome is going to be on inflation from this increasingly volatile world.

So, you know, the first thing you think about is, of course, that if firms and governments and households start to kind of hedge against a more volatile and uncertain world, they will accept efficiency losses at the gain of certainty increases. This is kind of a general mechanism - that those efficiency losses paid for resilience increases, If you want to call it like that, is something that is potentially inflation increasing.

So if you think about it very concretely, if you have long commodity chains which have very little stocks at many points in the chain, if we're living in a more and more risky environment because of geopolitical threats or maybe natural hazards, what have you, what may cause this increased risks, chains will either become shorter, there will be more stocks at each part of the chain, or they will be horizontal alternatives, which are also costly. So in the end, all that will be inflationary.

On the other side there's the counter weight. because if this volatility is going to dampen growth, then basically demand is just going to be lower, which is disinflationary.

And so how these two forces are going to play out in the end in inflation and therefore central bank policies and the way they think about this fundamentally in the long run, I find it's still a bit early days to to to be conclusive on that, to be honest.

How are central banks rethinking this great turbulence, this great volatility? My guess is that they'll rely on traditional instruments, they'll crank up interest rates, look for other ways to reduce economic growth. And that, of course, engenders all of the significant trade-offs with respect to the lives of all the people who are subject to those interest rates and being affected by inflation.

Abhinav Chugh: Just just on your point on building resilience and change, we have a question from one of our digital members which refers to how can we effectively and efficiently adjust demands that we are coming closer to living within planetary boundaries and become not so dependent on planned obsolescence without causing a massive recession. Important question, really, as we think about not looking at a just from a very economic perspective, but also planetary boundaries. Would you like to add to that?

Sandra Phlippen: I think that that is a fundamental question and it is actually also an economic question. Why is it an economic question? Because we know from a number of scenario analyses that we did, staying on the current path while ignoring planetary boundaries is going to be economically radically more costly than staying within those planetary boundaries. So it is also, from an economic perspective, the right thing to do.

And I'm actually I was thinking about whether I was going to say this or not, but I think actually that the current energy crisis, there is another silver lining to this and I think we should also be open about this. Because governments around the world are basically, you know, mostly introducing carrots and norms and to a lower than desired level sticks, in terms of carbon pricing.

And we as economists, we know that carbon pricing is the conditio sine qua non this transition is going to happen. Why? Because basically a lot of the solutions for decarbonisation need to come still from technologies and business cases that are still unborn. And in order to let them be born, we need to have the stick as well next to the carrot and the norms.

And I think that in absence of political willpower to introduce these sticks, I think a part of the price rise from the energy, let's say the punishment of of being energy intensive, which often goes hand in hand with carbon intensive, I think part of that price increase could be the speeding up of the transition now.

And I hope we're not going to take all of those incentives away. And therefore, I think that is also another silver lining of this energy crisis. While at the same time, I do want to emphasise that that does not mean that the lower incomes who don't have the means to to deal with the energy or the increased inflation or actually food cost in the developed world, let's please not forget about that. And so there needs to be sufficient support for that. But, you know, we see we are seeing so much energy price increases right now that at least part of it could be the right stick to to speed up the transition.

Abhinav Chugh: Erik. Anything to add to that?

Erik Peterson: I'll be very brief. I think that the punishing extreme weather events that we see across the world right now make the question asked by our viewer all the more profound. And I think also we need to take that even more seriously in the light of what I think are increasingly parochial national policies with respect to broader economic policies and other national policies that influence our capacity to work together to address some of these big global issues that exist. And that, I think, is a challenge to the economics community to thinkof new and practical and innovative ways in which we can be even more helpful going forward and groups across the board in terms of thinking how communities can work together.

Abhinav Chugh: Thank you. I want to take one more question from a digital member, what is the current economic situation in India? Is it stagflation? Any insights to share on an India?

Erik Peterson: We're projecting, as I've suggested, a decline in inflation in major economies across the world. India clearly has some degree of inflationary drag right now, but we're projecting that it will restore significant levels of economic momentum relatively soon. So I think everyone needs to be concerned about prospect of stagflation. But in effect, I think we're on a route in India back to the kind of significant growth environment that we saw prior to the pandemic.

Abhinav Chugh: I just want to ask one last question from my side. What are the top three things that countries can do right now to to tackle inflation? Sandra, over to you on this one.

Sandra Phlippen: Yeah. Well, I think the the the painful measure is actually on top of the list, which is demand destruction, because if you have a well, it depends on the region. Okay. So if you have home grown inflation like in the US, I think the the activities by the Fed is basically the key policy prescription which is also taking place. It's also painful but necessary. If you have imported inflation like on the European continent, then there is no way around demand destruction. And then basically there are two policies that come with that. One is basically to let the demand destruction happen naturally. That comes from the price increases. But intrinsically intertwined with that policy, it should be protection of vulnerable households, everybody. And that is not just the lowest income brackets, but with these energy bills, it should also be the lower middle incomes, I think. And to make sure that also people stay together in this and in this turbulence. And I think mainly for Europe, that is a major challenge with populist political forces strongly on the rise, notably in Italy. So this is another political challenge that the European continent has to face.

Abhinav Chugh: Erik, closing remarks on the top three things.

Erik Peterson: Top three things. First, we cannot allow perceptions of future inflation to occur. We need to find ways to extricate that from our thinking. And if that requires new policy pathways then we need to find them.

Second is that policymakers at night need to lay awake worrying about broader stratifications that have come not only with the pandemic and not only with the turbulence, but to be sure with the current bout of inflation that we're encountering.

And then finally, and this builds on what Sandra said, please, please, let's not politicise the debate on inflation. We need to get through this now in a way that helps us all move the economic needle back to a more stable environment for a broader, more robust future growth.

And then we need to be thinking about the critical elements, the global elements like climate change, extreme weather of geopolitical issues, etc., as we go forward with this.

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