If central banks react strongly against inflation, we already know what is coming: a recession

We have been with worrying inflation data for a few months. In Spain we have exceeded 6%In the US it is almost 7% and yes, in the euro zone it is at 5%, below these extremes but well above the universal 2% that central banks consider as a target.

Now the Central Banks are in a dilemma. Their mandate requires them to act by preventing inflation from spiking. But overreacting could have dire consequences for the still incipient economic recovery.

Interest rates and the possible recession

To crush inflation, the Central Banks have a very powerful tool: raising interest rates. If they do it decisively and with force, the monetary flow would clearly deviate and the inflationary spiral could stop. But nevertheless this would drag on our growth even leading to recession.

And a recession just when we have just come out of a very deep one is not good news. Central Banks must evaluate very well what the real risk of high and prolonged inflation is because the weapons they have to combat it are going to leave lots of collateral damage along the way.

Recession implies unemployment and poverty. Recession implies suffering. But it is also true that inflation also implies those things and that is why they are there Central Banks separated from politicians, because the latter prioritize the short term and do not want to see suffering at the cost of future benefits.

But wasn’t that what we were looking for?

We are facing an interesting paradox. The last crisis we had was financial due to a significant over-indebtedness of private hands, which ended up impacting the public accounts. One of the possible solutions to this crisis it is a somewhat higher inflation than usual, which reduces debts in real terms.

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Well, we already have here the much desired inflation to reduce public debts. However now we don’t like it. I honestly think inflation may be worrisome but we are still looking at a certain base effect (inflation last year was negative) and no indexing effects or high expectations just seen.

Therefore Central Banks should hold back a bit before acting. Leading us into a recession can be a worse shock than what you are trying to fix. I still remember Jean-Claude Trichet raising euro zone interest rates in 2011 for fear of inflation, aggravating the crisis that we could not get out of in Europe.


Source: El Blog Salmón by www.elblogsalmon.com.

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