Central Bankers’ concern that inflation will get out of hand

Catherine Mann, Bank of England policymaker, made the following statement that is indicative of the dilemma Central Bankers from G5 nations are deliberating:

“Going into 2022, current price and wage expectations coming from the monthly decision maker panel [a monthly business survey] are inconsistent with the 2 per cent target, and if they are realised in 2022 are likely to keep inflation strong for longer…It should be a concern that the costs from 2021 are becoming reflected in price expectations for 2022,” she said, adding: “Changing expectations is the first defence against a reinforcing wage-price dynamic.”

2% is the threshold that the most influential Central Banks in the world have adopted in order to manage their monetary policy in the context of maintaining a stable monetary system. When inflation is shoots above or below that threshold, it marks the point at which deliberations must take place to assure price remain stable. Unstable prices produce a lot of uncertainty, which hinders economic growth. When price are increasing at a faster pace than the expected 2% per annum, it means that the Central Bank must conduct monetary policy to the rate within the threshold range. 

However, when expectations from people get entrenched, especially when they look at the past in order to forecast the future, it becomes exceedingly difficult for Central Bankers to re-anchor those expectations. At this time, the market expects that Central Banks will reduce the money supply and be successful in reining in inflation. Why does the market believe this? Because it has worked in the past. The trouble would be if Central Banks fail in execution, which would then possibly lead people to lose faith in their ability to curtail inflation.