Inflation Surges and Monetary Policy (BOJ-IMES Keynote May 2022)

In May 2022, I delivered a keynote address at the Annual Conference of the Bank of Japan's Institute for Monetary and Economic Studies. the title was "Inflation Surges and Monetary Policy". It was published in the BOJ's Economic and Monetary Studies, vol. 40, Nov. 2022 and can be found at https://www.imes.boj.or.jp/research/abstracts/english/me40-4.html.

Here is the abstract: Similarities between the 1960s and 1970s raise concerns that central banks are repeating mistakes that led to the Great Inflation. Two explanations for this earlier period of inflation, that it was due to shocks and special factors or that it was the result of political pressures on monetary policy, seem particularly relevant today. Major central banks such as the Federal Reserve and the ECB have been slow to react to the surge in inflation due to COVID-19 and the war in Ukraine. I investigate the consequences of policy delay and the impact of a more aggressive reaction, conditional on policy being delayed. In assessing the persistence of inflation shocks and in dealing with uncertainty about inflation dynamics, policymakers seem to be ignoring lessons from the literature on monetary policy in the face of model uncertainty.

One interesting finding was that in a standard new Keynesian model, delay in responding to an inflation shock could lead to increased volatility of interest rates, but the impact of delay on output and inflation was relatively small. I interpret this as a reflection of the policy of forward guidance. As long as the private sector knows the Fed will eventually respond, delaying by a couple of quarters makes little difference. As usual, therefore, the credibility of the central bank is key. Too much delay, however, can lead to instrument instability.