Will Policy Changes Open the Door to Higher Inflation?

Central banks are being forced to address many challenges—inequality, climate change, and debt management to name but three. Given these tensions, will controlling inflation retain its overriding precedence? As priorities change, we believe inflation is on the verge of an important shift higher.

Until recently, central banks had a simple remit: maintain price stability. Now, they are being drawn into different areas: reducing inequality, supporting the green transition and so forth. If inflation becomes just another goal, there’s an increased risk that it will be traded off to focus on more pressing concerns.

Inflation Gamekeepers Turn Poachers

The COVID-19 pandemic has already forced central banks to stretch their mandates. It would not have been possible for governments to support their economies over the past 18 months and let debt levels reach record peacetime highs without assistance from massive central bank balance-sheet expansion and bond purchases.

While most developed-world central bankers continue to target inflation at around 2%, recent speeches suggest that they may already be taking their eyes off the ball (Display, above). Few (if any) historical episodes of high inflation started out as deliberate attempts to drive the price level higher. Instead, inflation arose indirectly as policymakers pursued other goals. We expect the same thing to happen in coming years. New policy imperatives, such as climate change and populism, are likely to push policy in a direction that, over time, generates higher inflation. Crucially, this will be seen as an acceptable price to pay.