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The New Crisis of Central Banking

For the past few decades, central banks have been at the vanguard of a successful campaign to ward off recessions, even in the aftermath of major crises. But their huge role in propping up markets has had dangerous unintended consequences, that can no longer be ignored.

LONDON – As veterans of past inflation battles know, central bankers must never lower their guard, because the monster is always there, stubbornly waiting for an opening. If central bankers ever think that they have finally prevailed over the problem – that they have a full understanding of all the factors underlying it – they will learn the hard way about inflation’s ability to reinvent itself. Too often, inflation finds allies, like the COVID-19 pandemic, that facilitate its return and confuse policymakers with complicated trade-offs.

That is why the credo of central banking is: Never belittle the inflation risk. To combat it, you must not only be decisive in response to changing circumstances; you also must be well ahead of the game. As Mohamed A. El-Erian of Queens’ College, Cambridge, rightly stresses, if you are saving your best options for a better day, you may already be behind. You cannot postpone a fight against inflation, because the problem is highly visible and creates contagious expectations that can quickly become entrenched. Hesitate and you run the risk of losing credibility, which will invariably make the fight longer and much costlier to wage.

Gradualism simply is not an option. If you have experienced high inflation, as one of us (Blejer) did as the president of the Central Bank of Argentina, you know that early inflationary symptoms cannot be ignored or dealt with later. The longer it takes to address the root cause (or causes) of inflation, the longer and more difficult the struggle becomes.