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It will take longer to bring inflation under control than most people think, but bringing it under control does not necessarily mean higher unemployment, and premature easing of monetary policy could be dangerous.
These are the main findings of a new IMF working paper released Friday, which examines lessons learned from more than 100 separate inflationary shocks across 56 countries since the 1970s.
Given its obvious timeliness, we’re surprised the paper hasn’t already made more noise, but Alphaville suspects it will provide ammunition for many central bank hawks at an interesting time for monetary policy.
Here is the text from economists Anil Ari, Carlos Mulas-Granados, Victor Mylonas, Lev Ratnovski and Wei Zhao:
We demonstrate that inflation was only reduced (or “resolved”) in 60% of cases over 5 years, and that even in these “successful” cases, resolving inflation took, on average, longer 3 years old. Success rates were lower and resolution times longer for episodes caused by terms of trade shocks during the oil crises of 1973 to 1979. Most of the unresolved episodes involved “premature celebrations”, in during which inflation first fell, then stabilized at a high level or accelerated again. Countries that resolved inflation had tighter monetary policy that was maintained more consistently over time, lower nominal wage growth, and less currency depreciation, compared to unresolved cases. Successful disinflations were associated with short-term output losses, but not with larger losses in output, employment, or real wages over a five-year horizon, which could indicate the value of political credibility and macroeconomic stability.
These are the abbreviated conclusions of seven “stylized facts” that IMF economists have drawn from their work on the data. You can read the full article here, but here are our brief summaries.
Done 1
Inflation persists, especially after terms of trade shocks
It is easy to think that inflationary shocks caused by a sudden explosion in energy or food prices will dissipate once the root cause (embargoes, wars, bad weather, etc.) has faded.
But inflation only returned to pre-shock levels after a year in 12 of the 111 inflationary episodes examined by the IMF, and in most of these cases this only happened because of a massive economic shock like the 2007-08 financial crisis or the Asian crisis. financial crisis of 1997-98. In other words, these were not examples of “immaculate disinflation.”
In 47 episodes examined, inflation had still not returned to normal after five years, and for the rest, the average time it took to return inflation to pre-shock levels was three years.
Done 2
Most unresolved inflation episodes have involved ‘premature celebrations’
This argument seems particularly relevant today. In almost all cases of persistent inflationary shocks, inflation fell “significantly” during the first three years, then stabilized at a high level or re-accelerated.
The IMF suggests this is likely due to premature easing of monetary policy or governments loosening the purse strings too early.
Done 3
Countries that overcame inflation had tighter monetary policy
One of the IMF’s key findings was that successful resolution of inflationary shocks generally occurred when central banks raised interest rates to combat them, whatever the cause:
The difference in monetary policy tightening between countries that have resolved inflation and those that have not is statistically significant, quantitatively large, and consistently established across different measures of stance. On average, countries that resolved inflation increased their effective short-term real interest rate by about 1 percentage point from the pre-shock position, while the real rate in countries that did not resolve inflation was on average 4.5 percentage points lower than the position before the shock. -shock.
Done 4
Countries that solved inflation stayed the course
The corollary of facts 2 and 3 is that the fight against inflation is generally successful when central banks raise interest rates and keep them higher for longer (and governments pursue restrictive fiscal policies). . Oh oh.
Done 5
Countries that resolved inflation experienced limited exchange rate depreciation
Another [annoyed grunt] point, to be honest. Countries that have managed to contain inflation (through higher interest rates for a longer period of time) have been able to either maintain their currency peg or limit the depreciation of their currencies.
Done 6
Countries that resolved inflation experienced lower nominal wage growth
As expected, countries with tighter monetary and fiscal policy experienced more moderate wage growth, while countries that did not experienced accelerated wage growth – but mostly in nominal terms .
In real terms, countries that managed to beat inflation saw only slightly less destruction of profit growth over time.
The IMF warns that the difference is too small to be statistically significant and could be skewed by a smaller sample (the data on wage growth is not good for the full sample). But it is interesting to note that the difference is quite modest.
Fact 7
Countries that BEAT inflation did not experience lower growth or higher unemployment
This is the most interesting discovery of the article. One might assume that aggressive tightening of monetary and/or fiscal policy would impose a heavy economic toll. But rather:
Over a five-year horizon, we find no statistically significant difference in growth outcomes between countries that resolved inflation and those that did not. Although inflationary shocks reduce growth and increase unemployment, whether resolved or not, the mean and median declines in output are slightly larger for unresolved episodes in the medium term.
What does that mean? To what extent is this historical exercise relevant to today’s problems? It’s hard to say.
It is telling that more than half of the episodes examined by the IMF were caused by the oil crisis of 1973-1979. As Isabella Weber et al. have written, energy is, along with food, one of the most “systemic” components of inflation.
But the recent surge in inflation was at least partly initially triggered by supply chain bottlenecks caused by the pandemic, then fueled by a demand shock as people went on a spree post-pandemic shopping and, more recently, by Russia’s invasion of Ukraine.
History could therefore be a poor indicator of the current situation. But some central bank officials will certainly see this as proof that they should go higher and remain restrictive for longer.
