The global economy has entered a new era of "big fluctuations"

Does "great easing" give way to "great fluctuations"? High inflation requires a strong policy response. On August 27, Isabel Schnabel, member of the Executive Committee of the European Central Bank, delivered an important speech at the annual meeting of global central banks in Jackson Hole, with the theme of "policy outlook after the epidemic". Schnabel pointed out that whether the COVID-19 epidemic and the war between Russia and Ukraine herald a turning point in macroeconomic stability, that is, whether the "great relaxation" will give way to "great fluctuations"? To answer this question, we need to think from two aspects: on the one hand, in the next few years, the epidemic and the war between Russia and Ukraine will lead to an unprecedented increase in macroeconomic fluctuations; On the other hand, the decisions made by central banks in response to high inflation can mitigate and limit the final impact of these shocks. Chu Xiao, a researcher of the Bank of China Research Institute, commented after analyzing the contents of Isabel Schnabel's speech that during the transition from globalization to anti globalization, the fluctuations of the world economy and related factors will further increase, and the globalization of inflation will make it more difficult for central banks to control price fluctuations.
A new era of "big fluctuation"
First, the special impact of the epidemic and the war between Russia and Ukraine has driven the inflation rate in the eurozone to an unprecedented high. In the past two years, the fluctuation of output growth in the euro area was about five times that of the peak of the great recession in 2009, and the inflation fluctuation rate soared to the level higher than that in 1970. Once the special impact of the epidemic and the war between Russia and Ukraine disappears from the data, the fluctuation of output and inflation will inevitably decline. Second, environmental uncertainty will exacerbate the impact of external shocks - larger, more lasting and more frequent. Climate change is a major driver. In recent years, the incidence and severity of extreme and destructive weather events are rising sharply, causing the global economy to face greater fluctuations in output and inflation. In the summer of 2022, the European Union is suffering from the worst drought in history, and nearly two-thirds of the region is in a state of alert or warning. Third, the two basic stabilizing forces of declining volatility - globalization and flexible energy supply - are affected, exacerbating future instability. On the one hand, globalization plays a huge shock absorber role. Since 1980, economic globalization has not only increased labor supply, but also improved production efficiency. Even in the period of strong demand, it has rarely achieved sustained upward pressure on prices and wages.
However, during the epidemic period, anti globalization and trade protectionism prevailed, which means the duplication and inefficiency of global production and the gradual dependence of countries on domestic production may make countries more vulnerable to external shocks in future development, rather than reducing them. On the other hand, the ability of elastic energy supply to absorb shocks in the next few years will also be weakened. Renewable energy has not been widely used. The green transformation and the war between Russia and Ukraine will make energy more scarce and expensive. In the short term, energy shortage forces the government to make "painful adjustments" to the production and consumption links of various countries; In the long run, although the production of various countries has changed to environmental protection technology to reduce the pressure of energy shortage, the energy impact will be further expanded during the transition period.
Macro policies should contribute
If the factors causing the "great relaxation" subside, reasonable policies will become more important in ensuring macroeconomic stability. First, fiscal policy will play an important role in enhancing economic resilience. Governments need to adjust their fiscal policies to cope with the risk of a long-term potential slowdown in output growth. Since the debt to GDP ratio is at or near a historical high, fiscal expenditure should focus on protecting social cohesion and promoting productive and green investment, which will help ensure long-term development and rebuild the fiscal space needed to cushion future shocks. Second, monetary policy needs to protect price stability. For the first time in 40 years, the central bank needs to prove its determination to protect price stability. The epidemic and war have led to a sharp rise in the prices of a large number of goods and services. The central bank can take two paths to deal with the current high inflation: one is a prudent path. This is consistent with the view that monetary policy is the "wrong medicine" to deal with supply shocks; The other way is to respond with determination. The central bank should strengthen its response to current inflation. Even if it faces the risk of slowing growth and rising unemployment, a prudent monetary policy can minimize the risk of low economic speed.
Inflation has become the number one enemy
The persistent uncertainty of inflation, the threat of the central bank's credibility and the potential cost of acting too late require the central bank to take a strong policy response to high inflation. First, there is persistent uncertainty about inflation. The more hesitant we are, the more difficult it is to control inflation. When the persistence of inflation is uncertain, the optimal policy stipulates that strong countermeasures should be taken against the deviation of inflation from the target to reduce the risk of long-term high inflation. In this case, it does not matter whether inflation is driven by supply or demand to a large extent. If the central bank underestimates the sustainability of inflation and adjusts monetary policy slowly, the cost of inflation may increase sharply. Second, the risk of inflation expectations falling off anchor is rising, and the credibility of the central bank is threatened. For an independent central bank, establishing and maintaining its own trust is an important policy objective. Failure to fulfill this trust may bring huge political costs. On the one hand, inflation expectations in the eurozone hit a new high. During the epidemic, the average long-term inflation expectation in the euro area gradually deviated from the established target of 2%. In July, the ratio was 2.2%, a record high. On the other hand, the central bank needs to pay less attention to stabilizing output. Policymakers should not stop when there are signs that inflationary pressures may change, such as the easing of supply chain disruptions. Instead, they need to demonstrate a strong determination to bring inflation back to target levels quickly. Third, the potential cost of acting too late, the central bank may face greater sacrifice. First, the sensitivity of economies to interest rates has decreased. This means that the decline in inflation expectations requires more tight monetary policy. Second, the slope of Phillips curve is more flat. Before the outbreak, the flat Phillips curve meant that the central bank could allow the economy to overheat before inflationary pressure appeared; Now, a flat Phillips curve means to reduce inflation. Once inflation becomes entrenched, it may need deeper contraction. Third, the correlation between the global economic situation and inflation is increasing. Compared with the 1980s, even if prices can respond more strongly to changes in domestic economic conditions, the central bank may also face a higher sacrifice rate, because the globalization of inflation makes it more difficult for the central bank to control price pressure.