Central banks such as the Federal Reserve should be prepared to tighten policy in case inflation gets out of control, the International Monetary Fund warned in a report Tuesday.
Although it agrees that prices will eventually ease, the IMF notes that there is “high uncertainty” around current forecasts.
A cautionary tone was set, mentioning the United States, the United Kingdom, and other developed economies, as areas where inflation risk was skewed to the upside.
In an executive summary accompanying the report, Gita Gopinath, the IMF’s economic counselor and director of research, stated that while monetary policy can generally weather transitory increases in inflation, central banks must be prepared to act quickly if rising inflation expectations become more material.
“Central banks should commit to contingent actions, communicate clear triggering events, and take relevant actions as a result,” she said.
In low-income countries, where food insecurity is most severe, food prices have increased the most, adding to the burden on poorer households and provoking social unrest.
A combination of rising debt levels, inflation, and weaker currencies against the US dollar creates tougher credit conditions for emerging and developing economies, which are forced to increase interest rates in order to limit inflation expectations.
The “continued grip” of the pandemic on global society is underpinning challenges like rising food inflation, food insecurity, and increased risk-taking in financial markets.
In its quarterly update on global economic conditions, the IMF issued the warning. Despite downgrading the outlook for global growth this year, the fund cut U.S. GDP forecasts substantially from its July estimate, albeit to a still strong 6%, which is ahead of developed economies’ forecast of 5.2%.
Since the Covid pandemic crisis began early in 2020, the Federal Reserve has had to wrestle with when to begin withdrawing its extraordinary policy support.
The IMF’s assessment on inflation does not specifically mention the Fed, but a substantial part of it addresses a major policy adjustment the Fed made in September 2020 when it said it would allow inflation to run above average in order to create full and inclusive employment.
Inflation expectations may surge if this type of policy is pursued, the IMF warned/
“There is a possible need for tighter monetary policy to respond to rising inflation amid still-low employment and the impending risk of expectations de-anchoring,” the report said.
Inflation would then be self-fulfilling, undermining Fed policy if we waited for employment to rebound stronger, the IMF warned.