Overwhelmed by insane imperial paranoia, Russia did not start a war against Ukraine at an accidental time.. The post-COVID economy, pumped up by monetary doping, has begun to recover in a completely different scenario than expected: demand has exploded amid disruptions in supply chains, employment has recovered, and a sharp increase in commodity prices and asset values \u200b\u200balready looks like a natural phenomenon. At the same time, China has formed huge food reserves, and Europe has found itself in an energy trap between values, strategic autonomy and the current efficiency of individual large businesses..

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Why doesn't this look like a coincidence The shrinking policy space and the rise of macroeconomic trade-offs have a direct impact on the political stability of democracies and the capacity for international coordination.. In other words, the narrower the policy space and the more complex the dilemma of macroeconomic choices, the more likely are internal political divisions that undermine the situation and make it harder to maintain focus on urgent geopolitical challenges..

Why is the monetary policy of the leading countries today found itself in a situation where each subsequent decision of the central banks does not guarantee the best result for maintaining political stability in democracies? First, the rate of inflation (see. rice. one). Even before the start of the war, it was obvious that inflation was getting out of control.. It doesn't just deviate from inflation targets in most of the world. And it is definitely not a reflection of some imaginary "

Second, the debt burden in developed countries and in many emerging markets (see. rice. 2). Low rates have corrupted governments over time. The COVID crisis has once again demonstrated that unlimited monetary stimulus makes budget deficits too affordable. Debt ceilings have shifted upwards, expanding room to respond to significant stresses. And now that employment growth is slowing, households are facing drastic pressure from energy spending, and military needs are clearly on the rise, governments will get higher rates on their borrowing..

Third, stagflation. Of course, modern stagflation is a bit different compared to its historical original (a combination of high inflation and unemployment, which goes against the basic macroeconomic assumption of Keynesian theory about the inverse relationship between the two). Today it is interpreted as a combination of higher medium-term inflation and lower growth (employment). In a more simplified form, the simultaneous combination of the worst forecast for GDP and inflation is a manifestation of this problem (see. rice. 3).

But even in this version, it is a challenge to central banks.. Raising rates to curb inflation could hurt employment outcomes. Why? Because there is still the problem of expectations. It is expectations that determine whether markets perceive the actions of central banks in line with the stabilization of the future situation, and not the loosening of the macroeconomic boat.. Confirming expectations with timely action and clarifying central bank decisions are the foundation of policy credibility. And although the credibility of monetary regulators has been shattered, their willingness to admit their mistake in interpreting the post-COVID inflationary surge is a good basis for preventing the situation in the world from falling back to the level of the 1970s.. But it is precisely this mistake that is the reason why the macroeconomic situation in many countries now looks much worse than it could be.. The room for maneuver for economic policy has become narrower, and the political vulnerability to focus on solving the greatest geopolitical challenge of our time has intensified..

Forecast data for 2022 even before the war turned out to be worse both in terms of inflation and growth rates. But now they look very optimistic.. Both the IMF and other financial institutions are unanimous that the war has only worsened the position of macroeconomic regulators regarding decisions on inflation and support for an economy whose momentum is fading under the pressure of commodity prices and tighter financial conditions..

Inflation in 2022 has convinced many skeptics in the central banking community that it is not temporary.. But the stubbornness with which monetary regulators recently noted the temporary nature of inflationary pressures is no longer surprising, but points to a number of weaknesses (not to say fundamental miscalculations) in the approaches on which their policy is based.. There are several key issues pointing to the serious macroeconomic vulnerability of the “updated” monetary doctrines..

Neglecting Supply Shocks. This position is explained by the limited ability of monetary policy to influence prices, which are under the influence of factors beyond the control of central banks.. That is, it is undesirable or even inappropriate to respond to them with the help of monetary policy.. Especially in cases where central banks are trusted. It depends on it whether short-term changes in individual markets will affect price-setting behavior and inflation expectations.. However, the issue of ignoring shocks, already traditional for monetary policy, sparkled with completely different colors in the light of the experience of 2021–2022.. In a globalized economy with interest rates lingering low, commodity prices behave more like an asset. They are becoming more sensitive to global monetary conditions, which mainly determine the level of interest rates and the slope of the yield curve.. In addition, the more globalized the economy, the more difficult it is to distinguish between a supply shock and a demand shock.. After all, the line between them becomes very conditional.. The same goes for individual countries.. Significant and protracted price corrections in individual markets change the balance of economic weight of different sectors. The solvency of economic agents that feed on price increases does not evaporate. It translates into costs that put additional pressure on prices.. An even more difficult problem is when supply shocks drive up core inflation.

Such cases are far from uncommon in emerging markets, where commodity shocks and demand accelerations are hardest to beat.. Because of this stereotypical ignorance of shocks, the supply may only be optimal in limited cases (during a natural disaster, for example, or crop failure). In the realities of 2022, it can be seen that as the war progressed, the so-called supply shock further intensified. But central banks are forced to respond to it, casting doubt on last year's argument that it can be ignored.. In other words, the increase in rates comes in the face of increasing signs of stagflation.. But it's already the best of the worst.

Changes in monetary strategies towards greater flexibility. In its purest form, the epitome of this flexibility is the average inflation targeting regime.. Its main idea was to increase the ability of the central bank to respond to an economic slowdown in the face of signs of deflation and interest rates close to zero.. Technically, this suggests that after a period of inflation deviating downward from the target, there may be a period of inflation above the target.. On average, over a certain period (little known, of course), inflation remains close to the target. It is clear that it is very convenient to position supply shocks as those that can keep inflation above the target.. However, this approach is extremely risky.. Its biggest problem is that targeting average inflation relies on the assumption that both prices and inflation expectations are more likely to decline rather than rise.. This is precisely the low probability of prolonged shocks in global commodity markets caused by monetary conditions in developed countries.. But if inflation is above the target for some time, there are no guarantees that inflation expectations will be sustainable.. This is what we see in many countries.. Inflation expectations worsen. And signs of stagflation intensify.

Inflation Buffer and Higher Inflation Targets. Higher inflation targets have been actively promoted since the global financial crisis. After the experience of finding inflation below the target, they began to promote the doctrine of the inflation buffer as a kind of " Its purpose is to prevent inflation from sticking below the target, which is set and communicated by the central bank.. This would seem to encourage an increase in nominal interest rates.. Higher nominal rates are seen as the best starting point if the central bank needs to cut rates to create monetary stimulus.. However, this approach relies on the same arguments as average inflation targeting.. However, within its framework, the questions of the relationship between the level of inflation and the level of interest rates are overly mechanistically interpreted.. The further inflation deviates from the target, the higher rates are required to tame it.. If inflation expectations destabilize, disproportionately higher rates in real terms are most likely needed. Therefore, there will be no benefits for the economy from the inflation buffer. But the risks of stagflation will appear. Moreover, they will be provoked by attempts to ignore surges in commodity prices..

Of course, the above questions of modern macroeconomic theory are not what unconditionally programs central banks to make a mistake.. But this poses a problem. The spread of a certain way of thinking increases the likelihood of errors, the overcoming of the consequences of which can cost the economy and the well-being of citizens too much. It is no coincidence that the inflationary fear of the 1970s and the equally disinflationary fear of the 1980s go hand in hand.. They point out that the wage-price spiral is one step moving many countries away from the Great Inflation period.. A move in this direction could undermine the achievements of central banks in stabilizing the economy over the past 30 years..

Is there a Ukrainian dimension to this discussion Definitely there is.

First, “cost-push inflation” has long degenerated into a cliche used by preachers of blue-yellow structuralism of the Latin American type to cover up the agony of the inability to implement reforms aimed at creating institutional prerequisites for inclusive economic growth.. Any shock to the economy, any spike in inflation or pressure from tariffs on the consumer price index is simultaneously denounced as both a stigmatization of attempts to protect the real incomes of citizens and businesses through adequate policies, and as "

Second, loose monetary policy or frustrated banking supervision traditionally has a large set of beneficiaries who masterfully promote the idea that central bank independence is a noose around the neck of economic development.. However, the nature of the distribution of income clearly shows that it is precisely those who do not have access to offshore companies, insider lending, raw material or corrupt rent that suffer the most from inflation and financial shocks..

Third, inflation and war. Unfortunately, the war has become a prime example of how everything related to inflation is written off as a supply shock.. However, post-war hyperinflation, of which there are many examples, and monetary and financial shocks in 1970–1990, with their expressive combination of devaluations and inflation, do not at all correspond to the modern narrative of flexible monetary policy.. A convenient excuse to print money is mainly rooted in an unwillingness to see inflation as a more complex process.. Ignoring the obvious risks of "

Unfortunately, the focus on interpreting current inflation solely as cost-generated runs counter to the very fact of the discrepancy between the economic potential that has been destroyed and the amount of money in circulation.. Part of the changes in the CPI, of course, is formed on the side of logistical gaps and the rise in energy prices. But that's not the whole story. Disbelief in the ability of money to store value in wartime breeds flight from it, provoking redollarization, overseas spending, unproductive consumption, or real estate acquisitions..

And finally, the creation of money by the NBU is increasingly absorbed by the budget. The limit of confidence in monetary policy in such a situation is determined only by foreign exchange reserves and operations to sterilize additional emission funds. And if trust is lost, no one will be interested in highly intellectual discussions about the nature of macroeconomic shocks.. War is not won by hyperinflation, nor should hyperinflation be the price of victory..

Read more articles by Viktor Kozyuk at the link.