The essay excerpted below, written by Philipp Hildebrand, vice-chair of BlackRock and former chair of the governing board of the Swiss National Bank, highlights some very interesting and complicating aspects of the policy dilemma currently facing the Federal Reserve.
“Financial markets have quickly repriced their monetary policy outlook and markets now expect at least seven incremental rate rises before the end of 2023… The pandemic caused a sudden, sharp shift in consumer spending away from services towards goods. Capacity — people and capital — cannot be expected to switch sectors so quickly. The result? Bottlenecks in goods-producing sectors as supply struggled to keep pace, but spare capacity in service industries… The Covid-19 shock and subsequent economic restart brought on supply constraints of a magnitude greater than for decades. Inflation has risen to levels not seen since 1982. Yet, far from running hot overall, the economy has not even reached its estimated potential level of output and employment… When inflation is driven by demand, judicious policy can in principle stabilise both inflation and growth. This is not possible in a world where inflation is the result of supply constraints. Heightened macro volatility becomes inevitable. Central banks have either to accept higher inflation or be prepared literally to destroy demand across the whole economy to ease supply constraints in one part of it.”