Inflation is not working

Economies with high core inflation tend to have the tightest labour markets; monetary policy is not enough to reduce inflation

‘If the only tool you have is a hammer, it is tempting to treat everything as if it were a nail’, Abraham Maslow

The US reported 9.1% inflation this week, the highest since 1981, with the Fed now scrambling to respond: markets are pricing a rate hike of 75bp or more later this month.  Surging inflation, and tightening monetary policy, is common across advanced economies and beyond.

This is partly an excess demand story, due to the strong economic recovery from Covid – supported by aggressive monetary and fiscal policy stimulus.  And rising energy and food costs have made a substantial recent contribution. 

More broadly, Covid has had an enormously disruptive effect on the functioning of advanced economies: global supply chain frictions, changed business models, dislocations in labour markets, and so on.  Combined with the strong recovery, these supply side constraints have generated inflationary pressure.

Indeed, inflation is importantly about structural dynamics.  Factors such as globali…