The author is a professor of economics at Tel Aviv University, a research fellow at the London School of Economics (LSE), and a consultant to the Bank of England
The global inflationary outbreak is now the worst in more than 30 years. During 2021 it became clear to economists and policymakers that the inflation rate was climbing rapidly and breaking all forecasts. They were forced to act on the sarcastic advice of Edgar Fiedler, the US Deputy Secretary of the Treasury in the 1970s, who said: “If you have to forecast, forecast often.” 2021. The Bank of Israel is expected to join soon.
After more than 30 years of relative stability, with inflation rates below 2% per year, in 2021 inflation was 4.7% in the US (and above 7% is expected this year), 2.6% in the UK (and above 7.5% This year, and 2.6% in the eurozone (and close to 7% this year). Why? Stability was achieved after the leading central banks pursued a conservative and stable policy that gained credibility in the public and markets; Of supply of products and inputs for production from East Asia, products marketed worldwide.At the same time, the epidemic forced the fiscal and monetary authorities to adopt an expansionary policy to prevent a huge collapse and crisis. 9.4%, and in the eurozone by 6.5%. Government aid contributed to an impressive recovery in 2021, including a 5.7% rise in the US, 7.5% in the UK, and 5.3% in the eurozone. Now the Russia-Ukraine war crisis is leading to further supply shocks, and especially to rising energy, metal, and commodity prices.
Growing concern
During 2021, therefore, the central banks added an increasing concern about the acceleration of inflation, in addition to the concern about activity in the economy (ie an increase in GDP and employment). It should be borne in mind that the spread of the variants, the Delta and the Omicron, have created significant uncertainty both regarding the scope of economic activity and regarding the future inflation route. The dilemma was whether to raise interest rates and thus harm economic activity and potentially also create a crisis in the financial markets, or leave interest rates at very low levels and allow inflation to rage. It now appears that in 2022 there will be a slowdown in activity to the point of recession along with relatively high inflation, ie stagflation. The financial markets have already experienced significant declines in the first quarter of the year.
The dilemma of central banks therefore still exists, and this is evident in disagreements among interest rate makers. However the direction has started to become clearer in the last month and all central banks have started raising interest rates. This is mainly because there is a feeling that the relatively late response, especially by the Fed, is undermining the stability of public expectations of inflation. Economic research, including research from recent years and months, shows that these expectations play a crucial role in determining the level of inflation and its persistence over time.
The right context
In this state of affairs, the Bank of Israel does not have much room for maneuver. But it is important to put things in the right context. Israel has so far enjoyed the benefits of relatively low GDP damage in the corona crisis and inflation that has risen but much less than what was experienced in the West. Thus, the decline in Israel’s GDP in the corona crisis was lower than the figures mentioned above, only 2.4% in 2020, and the subsequent increase is 8.1% in 2021. According to the CBS publication, the trend data of the Consumer Price Index show an annual inflation rate of about 3.6% now. This rate is above the inflation target range (which is between 1% and 3%) but these are not the high numbers mentioned above. Good data These have therefore supported the change in interest rates for a long time, and this has not changed since November 2018. However, the crisis in Ukraine, as the Israeli economy is a very open economy exposed to rising energy and commodity prices, rising inflation expectations. The bank), and rising housing prices will lead the bank to raise interest rates. The latest interest rate announcement of 21 February stated explicitly: “Committee members estimated that in the coming months the conditions will mature to begin a gradual process of raising interest rates according to the inflation route.”
The challenge will be to be attentive and alert to developments. Many good people have erred in their inflation forecasts in the big countries. In general, it is worth noting that major events were not really foreseen: the great financial crisis in 2008, the corona crisis in 2020, and the Russia-Ukraine war in 2022. Within 14 years it became clear that situations had arisen that the world had not known since the 1930s, 1940s, and 1970s. In the face of these surprises, the identity of policymakers is very different. The question of who heads the state, heads the Ministry of Finance, and heads the central bank everywhere is of great importance. Some of these personalities are chilling, some are inspiring. The world, including the economic world, is in a special period, a turbulent era.