Context: Pandemic has set the stage for a decade of churn. Post-Covid economy needs intellectual re-evaluation.
Challenges before Central Banks in post-covid recovery phase
Ideological threats: Serious doubt on long-standing wisdom that economy functions best with an “invisible hand” and it should not be jeopardised through government “intervention”.
In many countries, including in the US, industrial policy is back on the table.
Issues in global economic order: which is characterised by more markets, greater financialisation, less government and freer trade culminating in wider inequality and higher debt burdens.
Rising Inflation: Inflation remains the greatest challenge before central banks globally.
Precarious expectations: Structural supply side issues and elevated inflation expectations will likely fuel a global inflation cycle.
Technical difficulties in interpreting inflation: In modern version of Phillips curve, inflation depends on economy output gap variables and inflation expectations.
In India, link between inflation change and output gap was never strong, and with emergence of Covid-19, the link is completely lost.
Thus, the concept of output gap is grossly inadequate to explain the inflation behaviour in India.
“Inflation expectations” is not stellar, to drive the sustained inflation in post pandemic phase.
Monetary policy paradox: To counter inflation, Central Banks can hike interest rates, but there are underlying problems associated with it, because
Every stakeholder is addicted to low or no rates.
Inflation caused by supply disruption is not amenable to monetary treatment.
Bias in fiscal transfer measures in developing countries:
In US, government debt held by Federal Reserve banks increased by $3 trillion from end of 2019 till the second quarter of 2021.
The privilege for America is excessive whereas the burden is exorbitant for developing countries if they seek to emulate such a fiscal transfer from the central bank to the government.
Crisis in energy sector: Within a year, global energy market gone from massive glut to massive shortage.
Investment gap: In last decade, due to very minimal investments in commodities exploration, supply chains are significantly unprepared to meet the demand.
Despite shortage in semiconductor market, there are no closed plants to reopen.