Recent monetary tightening by many central banks across the world will help prevent high inflation from becoming entrenched and staying above target for too long, the International Monetary Fund (IMF) says.
“Front-loaded monetary policy tightening, including through its clear communication, can lower the risk that inflation will become de-anchored from its target,” an IMF analysis published on October 5 said.
“Given that inflationary shocks are originating outside the labor market, falling real wages are helping to slow inflation, and monetary policy is tightening more aggressively, the chances of persistent wage-price spirals emerging appear limited,” said the analysis, a part of the IMF’s latest World Economic Outlook.
Both developed and emerging economies across the world have been raising interest rates rein in inflation that has spiked to multi-decadal highs.
Fight against inflation
Last month, the US Federal Reserve raised rates by 75 basis points for a third straight time and forecast they would reach 4.6 percent in 2023. The Reserve Bank of India has raised its key repo rate four times by a cumulative 190 basis points since May to a three-year high of 5.9 percent.
The Fed’s sharp rate hikes have battered stocks and emerging market assets.
Central banks across the globe had undertaken unprecedented monetary easing after the pandemic hit the world in 2020. Supply chain issues and intermittent lockdowns exacerbated price pressure.
This year, a commodity price surge following Russia’s invasion of Ukraine also raised costs for consumers and companies. Europe is facing a prolonged energy cost surge as Moscow has cut gas supplies.
Wages in developed economies have also risen sharply as economies have reopened as the pandemic has eased.
The current coincidence of rising inflation and nominal wage growth has led to concerns that a wage-price spiral—in which both wages and prices accelerate for a prolonged period—could emerge, the IMF said.
Although wage and price inflation picked up in a broad-based manner through last year, real wages tended to be flat or falling across economies on average, the agency added.
“This is an important aspect of the current conjuncture, since falling real wages can be disinflationary by lowering firms’ real costs,” the IMF analysis said.
“An analysis of historical episodes with features similar to today’s suggests that these episodes did not tend to be followed by a wage-price spiral. In fact, inflation tended to fall gradually afterward on average, and nominal wages gradually caught up over several quarters.”
When wage and price expectations are more backward-looking, monetary policy actions need to be more front-loaded to minimize the risks of inflation de-anchoring, the IMF said.
As monetary policy tightens more aggressively and a decline in real wages helps reduce price pressures, the risk of a persistent wage-price spiral emerging is contained, assuming no more persistent inflationary shocks or structural changes, it added.
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