Harvard University Economist Kenneth Rogoff said the world is headed into a “new era” with more inflationary headwinds that may force central banks to boost interest rates.
Speaking at a Bank of Japan web event, the former International Monetary Fund chief economist said factors that once reduced consumer prices are now headed into reverse and likely to leave inflation higher than policy makers expect. The result will require a firm response by moving interest rates to higher levels.
“A retreat from globalisation is turning tailwinds into headwinds and could make the political economy pressures on central banks considerably more intense, potentially leading to higher time-consistent equilibrium inflation rates,” Rogoff said at the event on Wednesday in Tokyo.
The remarks highlight a shift away from measures in place to stimulate economies through the global financial crisis more than a decade ago and then the coronavirus pandemic. Policy makers pushed borrowing costs close to zero or lower and used new monetary instruments like quantitative easing.
Now, those steps have undermined the authority of central banks to combat the inflation they’re now seeing, Rogoff said, suggesting that economists have become too complacent about the trends that are now unfolding.
“Academic research in the inflation targeting era has taken central bank independence far too much for granted,” Rogoff said. “In fact, favourable tailwinds from globalisation and technology made balancing growth and inflation easier and reduced political economy pressures.”
Reducing rates to near zero, “undermined the effectiveness of the instrument” central banks use to keep a lid on inflation, he said.
Rogoff said it’s likely to be difficult for central banks to reign in inflation especially after the global economy has suffered from the coronavirus pandemic. He indicated that this round of inflation is different from the one that Paul Volcker had to deal with when he led the US Federal Reserve in the 1980s.
“Raising interest rates and taking a risk of recessions are always pain,” Rogoff said. After the pandemic, the political appetite and “the public tolerance for having a central bank that says inflation is bad and that we have to have a recession is very, very low.”