International Monetary Fund First Deputy Managing Director Gita Gopinath told officials at the European Central Bank Forum on Central Banking 2023 that while some of the key elements of inflation have been contained, others could still cause economic strife.
Gopinath spoke to the Central Bank Forum on June 26 in what she called "a critical time for central banking." She focused on how to contend with high inflation "by confronting what I will call three uncomfortable truths for monetary policy."
"The battle against inflation is very much ongoing, both in the euro area and around much of the world," Gopinath said. "Headline inflation has declined, but the stickier components remain persistently high. Central banks must continue to fight high inflation now, while also determining if—and how—monetary policy strategy may need to change in the future."
She said the first unsettling fact is that it is taking too long for inflation to return to the target level. "This means that central banks, including the ECB, must remain committed to fighting inflation despite risks of weaker economic growth," she said. Secondly, tensions between price and financial stability objectives of central banks may arise as a result of financial stress. It is possible to achieve "separation" using extra instruments, but it is not guaranteed.
Third, central banks are likely to face more upside inflation risks in the future than they did before the pandemic, she said. That makes it necessary to improve monetary policy methods and the application of instruments like forward guidance and quantitative easing.
"Since it peaked two years ago, inflation experts have been confident that it will rapidly return to target," Gopinath said. "This also includes the ECB and the IMF, whose predictions are almost identical. These charts show that inflation is significantly higher than expected. This makes me think of the well-known play 'Waiting for Godot' by Samuel Beckett. Both the cast and the audience in the play wait for the enigmatic Godot persona, who never shows up. In a similar vein, we continue to wait for low inflation to return."
There is reason for concern, she said.
"Naturally, we hope that real life will end differently than the drama. The audience is still waiting, though, as of right now. Markets continue to be particularly hopeful that inflation in the euro area and the majority of advanced nations will decline to close-to-target levels reasonably rapidly despite repeated forecasting failures," she added.
"Despite central bank advice to the contrary, predictions that policy rates will reduce shortly are supported by these disinflation hopes, which are likely exacerbated by the strong decline in energy prices. Similar findings from surveys of market analysts imply that inflation is expected to decline without much of a hit to growth. It is important to remember that there is little historical precedent for such a result," she said.
