Letter: Central banks must also take into account the risk of deflation


Economists are quick to warn that central banks should not abandon monetary tightening too soon. The argument is echoed in a quote from the IMF used in Martin Wolf’s column “Disease and War Shape Our Economy” (October 12).

Wolf quotes the fund’s latest World Economic Outlook: “Yielding to pressure to slow the pace of tightening will only undermine credibility, allow inflation expectations to rise and require more aggressive and painful policy actions more late”.

But even if correct, this analysis ignores that there is actually a risk both ways with monetary tightening. Higher entrenched inflation is a risk. But there is a second risk, at least as serious, if not more so.

If central banks drag economies into recession, they could quickly find themselves in the predicament of the 2010s, with deflation – not inflation – the main concern and monetary policy again constrained by the zero bound.

It would also require “some painful policy actions,” such as negative interest rates and even more quantitative easing. It’s an experience most central banks don’t want to repeat. They barely escaped this predicament in the past year (Japan’s central bank may still not have escaped).

This is an often overlooked aspect of rising inflation. This is undoubtedly a difficult trade-off, but if monetary policy is too ambitious, it risks bringing us back to square one.

Bill Smith
Bagshot, Surrey, UK


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