Is high inflation a short-term or long-term problem?

The worldwide spike in consumer prices over the past year has spurred debate about the longer-term trajectory of inflation.

In the decade before the pandemic, the chief concern of the world’s leading central bankers was inflation being too low. Today, they are scrambling to get a handle on soaring consumer prices and cautioning that the era of benign inflation is a thing of the past.

“There are forces that have been unleashed as a result of the pandemic, as a result of this massive geopolitical shock that we’re facing now, that are going to change the picture and the landscape within which we operate,” Ms. Lagarde said. There is plenty of disagreement on each of these issues. But there’s a sense, at least among influential central bankers, that we’re at a turning point. Advanced-economy inflation is no longer a relic of the past. Going forward, policy-makers will face difficult trade-offs to keep prices stable.

This dynamic, known as a wage-price spiral, took root in the 1970s and proved hard to dislodge. It took punishingly high interest rates and a deep recession in the early 1980s – known as the Volcker Shock, after then-U.S. Federal Reserve chair Paul Volcker – to finally break the inflationary mindset.

Rafael Gomez, professor of employment relations at the University of Toronto, says a 1970s-style wage-price spiral is unlikely given the decline in labour’s bargaining power in recent decades. Central banks also have more credibility today, which could anchor expectations. When explaining the period of low and stable inflation that began in the mid-1980s, economists often point to globalization. The development of worldwide supply chains lowered manufacturing costs and brought hundreds of millions of workers into the international labour pool, putting downward pressure on wages.

A closely related concern has to do with changing demographics. An influential argument, popularized by British economists Charles Goodhart and Manoj Pradhan in their 2020 book, suggests that the key driver of low inflation in recent decades was China’s entry into the global economy.

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