Addressing inflation pressures

The resurgence of the pandemic and the latest variant, Omicron, have sharply increased uncertainty around global economic prospects. This comes as several countries grapple with inflation well above their monetary policy targets. It is however evident that the strength of the economic recovery and magnitude of underlying inflationary pressures vary significantly across countries. Accordingly, policy responses to rising prices must be calibrated to the unique circumstances of individual economies.

We see grounds for monetary policy in the United States—with gross domestic product close to pre-pandemic trends, tight labor markets, and now broad-based inflationary pressures—to place greater weight on inflation risks as compared to some other advanced economies including the euro area. It would be appropriate for the Federal Reserve to accelerate the taper of asset purchases and bring forward the path for policy rate increases.

Over time, if inflationary pressures were to become broad-based in other countries, more may need to tighten earlier than currently expected. In this environment it is essential for major central banks to carefully communicate their policy actions so as not to trigger a market panic that would have deleterious effects not just at home but also abroad, especially on highly leveraged emerging and developing economies. Needless to say, given the extremely high uncertainty, including from Omicron, policymakers should remain agile, data-dependent, and ready to adjust course as needed.

Rising energy and food prices have fueled higher inflation in many countries. These global factors may continue to add to inflation in 2022, especially high commodity food prices. This has particularly negative consequences for households in low-income countries where about 40 percent of consumption spending is on food.

A measure of inflation which strips out volatile fuel and food inflation, so-called core consumer price inflation has also risen but exhibits significant variation across countries. Some of the increase in core inflation in countries reflects reversals of price falls in 2020, such as from the unwinding of VAT tax cuts in Germany. It therefore helps to focus on annualized cumulative inflation since pre-pandemic. By this measure, core inflation among advanced economies has risen most sharply in the United States, followed by the United Kingdom and Canada. In the euro area the increase is much less so. There are also limited signs of core inflationary pressures in Asia, including in China, Japan and Indonesia. Among emerging markets, core is dramatically elevated in Turkey.

Median inflation, a measure that is not affected by exceptionally large or small price changes in a few categories of goods and therefore conveys the breadth and likely persistence of price pressures, similarly varies across countries. The recent rise in median inflation for the United States to around 3 percent in October is also higher than for other Group of Seven countries

While inflation is likely to remain elevated well into 2022 in several countries, measures of inflation expectations for the medium and long-term remain close to policy targets in most economies. This reflects, in addition to expectations of waning inflationary forces, that policy actions can bring inflation back to target.

In the United States, long-term inflation expectations have increased but remain close to historic averages and thus appear well-anchored. Euro area expectations have increased but from levels well below target to now close to it, which suggests long-term expectations may have become better anchored to the European Central Bank’s 2 percent objective. For Japan, inflation expectations remain well below the target.

For several emerging markets, including India, Indonesia, Russia, and South Africa, expectations show signs of being anchored. Exceptions include Turkey, where the risk of inflation expectations becoming unmoored is apparent as monetary policy is eased despite rising inflation.

The rise in core inflation reflects multiple factors. Demand has rebounded strongly supported by exceptional fiscal and monetary measures, especially in advanced economies. In addition, supply disruptions caused by the pandemic and climate change, and a shift in spending toward goods over services have increased price pressures. Furthermore, wage pressures are apparent in some segments of labor markets. The United States has experienced a more prolonged reduction in labor-force participation relative to other advanced economies, further adding to wage and inflationary pressures.

IMF