Economies may face volatile inflation in coming years, says ECB president

Deep changes in the global economy could make inflation volatile in the coming years, complicating efforts to control prices, but sticking to targeting regimes is still the best option, European Central Bank President Christine Lagarde said on Friday.

+ With Selic now at 10.75%, what will happen to savings, Treasury Direct and CDB yields?

Economic shifts from deglobalization and rising protectionism to vast technological advances have puzzled economists over the past decade, and most failed to foresee the recent rise in inflation, leaving central banks behind the curve, playing catch-up in their efforts to control prices.

Lagarde, who took over the ECB just months before the Covid-19 pandemic hit, argued that a more uncertain world lay ahead, which demanded greater flexibility rather than new mandates.

“If we enter an era where inflation is more volatile and the transmission of monetary policy is more uncertain, it will be essential to maintain this deep anchor for price formation,” she said at an International Monetary Fund (IMF) event in Washington.

“But that doesn’t mean the way we conduct monetary policy will remain the same.”

One of the main changes is related to the dominance of large companies in the digital world, including cloud services, e-commerce, internet searches and, possibly, artificial intelligence.

Very large firms are less dependent on external financing and have a smaller labor force, so they are less sensitive to interest rate changes and, consequently, reduce the ability of central banks to guide the economy.

A reversal in globalization could backfire, boosting central banks if companies shorten their supply chains through “nearshoring” or “friendshoring,” Lagarde argued.

Setting up shop closer to home would also increase capital needs, so companies could become more sensitive to changes in interest rates.

“Capital deepening could increase the economy’s sensitivity to interest rate changes, potentially increasing the effectiveness of monetary transmission,” Lagarde said.

The problem is that these changes could also be accompanied by greater inflation volatility, especially if AI giants are less sensitive to monetary policy and manufacturing-focused companies are more affected.

The growing participation of fintech companies in lending will also add to the problems of central banks.

These companies are more efficient in granting credit to the economy, but also more sensitive than regular banks to changes in the environment.

“This responsiveness also means that fintech lending can be more pro-cyclical in times of stress, extending credit cycles and volatility,” Lagarde added.