Central bankers in continental Europe, Britain and America have been wrestling with how to respond to the jump in prices. If they overreact to inflation that is temporarily elevated by factors that will soon fade, they could slow labor market recoveries unnecessarily — and may even doom themselves to a future of too-low inflation, much like the situation Japan faces.
But if shoppers come to expect consistent inflation amid today’s burst, they may demand higher wages, fueling an upward cycle in prices as businesses try to cover climbing labor costs.
Monetary policymakers want to avoid such a situation, which could force them to raise interest rates sharply and spur a serious economic slowdown to tank demand and tame prices.
“There’s a tension between our two objectives: maximum employment and price stability,” Mr. Powell said. “Inflation is high, well above target, and yet there appears to be slack in the labor market.”
“Managing through that process over the next couple years, I think, is the highest and most important priority, and it’s going to be very challenging,” he added.
For now, most top global officials are preaching patience, while moving to gradually reorient their policies away from full-blast economic support. The Fed is preparing a plan to slow its large-scale bond buying, which can keep money pumping through the financial system and lower many types of borrowing costs, even as its policy rate remains at rock bottom. The Bank of England has signaled that policy will need to be tightened soon, and the European Central Bank is slowing its own pandemic-era purchase program.
“The historical record is thick with examples of underdoing it,” Mr. Powell said, noting that economic policymakers tend to underestimate economic damage and under-support recoveries. “I think we’ve avoided that this time.”