Thread by @jacobotweetsnow

FT opinion article: “Central bankers should think twice before pressing the brake even harder - The war against Ukraine has brought a new negative supply shock on top of the old one”. Harder? Thread #bonds #equities #centralbanks #monetarypolicy ft.com/content/41c248…

1/According to the author the invasion of Ukraine has silenced the debate about “transitory” inflation. But where central banks stood impacts how they react. Initially the idea was that inflation was the result of supply issues that could be ignored. This view lost out.

2/Central banks made hawkish turns and have painted themselves into a corner, as the Ukraine crisis has brought a new supply shock. Central banks committed to tightening when the second shock made things worse.

3/Policymakers insist they are data dependent but have so far ignored the opportunity to restate in view of the invasion. Central banks also need to review how they think policy works, a severe war involving commodity exporters calls for pressing the brakes harder?

4/Tougher monetary policy could get in the way of the reallocation of resources that is needed for new capacity. Insufficient reallocation means lower productive potential, either raising inflation in the future or increasing the cost of keeping it low.

5/Facing a pandemic, a war and climate change, which requires huge structural shifts, how is it right for central banks to delay investment/jobs growth? Until they can answer the question, they should be less eager to tighten.

6/IMHO the author is right in that there has been a new supply shock (maybe more to come). And this should lead to greater caution. But inflation is not only a supply issue.

7/For a commodity supply shock to result in widespread inflation there has to be enough demand to absorb it without the price of other items falling as households “reallocate” resources. The “extra” demand is not an external shock. It’s due to monetary/fiscal policy.

8/The “Putin hike” was made possible by Powell/Biden policies (in the US, with equivalents in other regions). Even if the catalyst was a supply shock, a reduction in demand is likely still needed to lower inflation.

9/The question is now if the “extra” demand is transitory (if wages do not keep pace and savings are run down), or whether it will have to be beaten down via monetary/fiscal policy. Proposed tightening is hardly “hard” (so still “hopium”), but “harder” might be too much.

10/They key is to identify to what an extent supply and demand issues are transitory (“reallocation” of supply could take some time and lowering demand is painful). I hope they offer courses in Blackjack in central bank academies. I would not bet on it.