• With its 50 bps interest rate hike, July 21st, the ECB joins the global fight against high inflation, which is at 40-year highs in several countries.
  • In contrast to the late 1970s-early 1980s, however, central banks have a clear policy framework and commitments to price stability to guide their decisions. This is a crucial difference between then and now.
  • Inflation-targeting regimes thus provide some assurance that the current inflationary environment won't be "déjà vu all over again."

The ECB's July 21st 50 basis point increase in the policy rate, double what it had signaled in June, is the latest salvo in global central banks' fight to contain inflation. To be sure, there is a lot of inflation to fight. And with the latest readings in several countries coming in at 40-year highs, there has been a predictable uptick in media attention to the parallels with the inflationary environment of the late 1970s-early 1980s. As the noted American social philosopher, Yogi Berri, is purported to have observed, "it is déjà vu all over again." Or is it?

While a scenario of sustained high global inflation cannot be completely discounted, there is good reason to believe that it is unlikely. Yes, there are similarities between the international economic conjuncture four decades ago and today—most notably, the importance of supply-side shocks (OPEC I and OPEC II then; Russia's invasion of Ukraine now). But there is one huge difference.

Forty years ago, central banks around the world were still grappling with the consequences of the demise of the Bretton Woods system that had governed international monetary (exchange rate) relationships since the end of the Second World War. The loss of that monetary policy framework led central banks to search for a replacement. Initial attempts to control inflation by limiting the growth of various measures of the money supply (M1, M2, M2+, etc.), as advocated by Milton Friedman and other "monetarists," proved unsuccessful.

For much of the past four decades, however, most central banks have adhered to inflation-targeting frameworks. That is the crucial difference between the inflationary environment of the 1970s–1980s and today. It is why Latam central banks were early movers in the inflation fight. Moreover, public commitments by central bankers, backed up with policy action, to return inflation to target have kept inflation expectations anchored despite the enormous price shocks that have been experienced over the past year. And that adherence to price stability commitments by central banks in the region and around the world is why it probably isn't "déjà vu all over again."

These frameworks thus represent an essential difference in operating procedures. Yet, as noted above, that fact doesn't preclude the possibility of sustained high inflation—if the global economy continues to be subject to a series of ongoing supply-side shocks, for example. Nor does it necessarily prevent an unintentional policy "overshooting" should central bankers, anxious to defend their credibility, independently err on the side of restraint, resulting in an accumulated response that leads to excessively tight global financial conditions. Such responses may be warranted and rational from the perspective of individual central banks, but collectively irrational if they raise the risk of global recession. In its reliance on credible commitments, inflation targeting could share certain features of the dysfunctional gold standard a century ago, which the Bretton Woods system was intended to correct. That truly would be a case of déjà vu.

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