Central banks should live with inflation rather than destroy demand and economic activity says BlackRock.
A new paper from the BlackRock Investment Institute, titled ‘A World Shaped by Supply,’ concluded that central banks should accept supply-driven inflation rather than destroy demand and economic activity, as long as inflation expectations remain stable.
The research found that during the economic recovery, consumer spending shifted dramatically toward goods and away from contact-intensive services. As a result, there are both severe bottlenecks and spare capacity. Prices tend to rise faster in response to bottlenecks than in response to spare capacity, resulting in higher inflation, despite the fact that overall economic activity has not fully recovered.
Researchers predict that more macro volatility will result from a world shaped by supply constraints and that monetary policy cannot simultaneously stabilise both inflation and growth.
The findings also highlighted that if central banks had sought to keep inflation close to 2 per cent despite the supply constraints encountered during the restart, this would have required driving the unemployment rate up to nearly 10 per cent.
Additionally, the restart demonstrates how the transition to net-zero emissions will unfold: it will be similar to a lengthy restart. As energy prices rise, supply constraints will bind the economy as a whole. Supply bottlenecks will result from large shifts across sectors. Both will contribute to inflation, as will the restart.
BlackRock says that climate change will increase inflation, whether or not carbon emissions are reduced. If all of the additional costs of a transition are passed on to consumers, consumer prices could rise by as much as 4 per cent by the early 2030s. A smooth, even transition would raise inflation by 0.4 percentage point per year. If the shift occurs faster, the impact on inflation will be greater.