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We now understand how little we know about inflation – Fed’s Jerome Powell

The current high levels of inflation in both the United States and Europe have provided an opportunity for central banks to “get a better understanding of the extent of our understanding of inflation.” Federal Reserve Chairman Jerome Powell said.

Speaking at the European Central Bank (ECB) Central Banking Forum in Portugal on Tuesday, Powell acknowledged in his comments that central banks during and before the COVID-19 pandemic do not fully understand inflation and its causes.

Powell said that the current high levels of inflation are not predicted by economists and the models they use, but are based, he says, primarily on the Philips curve.

Nearly all forecasters expect inflation to be below 4 percent last year, according to Powell. However, they are all using the same Philips curve model, which, he says, is “just not capable of generating high inflation“.

We were in a world where inflation wasn’t an issue, but things changed after the pandemic, Powell said, noting that we had “a series of supply shocks,” which eventually led to “very high inflation.”.

Making things worse, the war in Ukraine has “added a lot” to inflationary pressures on food and energy commodities, the Fed chair added.

The same view was also shared by Agustín Carstens, General Manager of the Bank for International Settlements (BIS), who said in the same discussion that central banks still do not fully understand inflation.

We understand inflation a little bit better, but not fully,” Carstens said.

Commenting on how the Fed will now work to bring inflation back down, Powell made it clear that while “we can influence the demand side, we can’t really influence the supply side.

Powell added that growth will need to be “moderate” for inflation to come down, and said this is what the Fed is trying to achieve when it comes to raising rates. Additionally, Powell said the Fed “hopes that growth can stay positive,” although he acknowledged there is a risk that it won’t.

Certainly, there’s a risk that we’ll go too far,” he said of the Fed raising rates, before adding that “failing to restore price stability” would be an even bigger mistake. more if you get it.

Still, Powell remains optimistic that it is possible to bring inflation down quickly, relying on the very forces that brought it up so quickly.

He said that demand for things like cars “straightened” during the pandemic, partly because people don’t want to use public transportation, while auto companies don’t produce enough new cars. This led to massive price increases, Powell said, before adding that “in principle, at least, that process could work in reverse as well.

“As demand falls, inflation can fall faster,” he said.