WASHINGTON, July 27 ― Global central banks may get “antsy” about the swiftness of economic pain brought on by monetary tightening to fight inflation and be tempted to cut interest rates before the job is done, the International Monetary Fund's chief economist said yesterday.

That would be a huge mistake, prolonging the agony of inflation, IMF research director Pierre-Olivier Gourinchas told Reuters in an interview.

Gourinchas said rate hikes like the one expected from the US Federal Reserve today are already raising borrowing costs and softening demand. That process needs to continue until inflation rates are back “within sight” of central bank targets of around 2 per cent a year, he added.


The IMF cut its global economic growth outlook yesterday, as it warned that monetary tightening, along with spillover from the war in Ukraine and Covid-19 lockdowns in China, could push the global economy to the brink of recession in the coming months.

“And so central banks might be a little bit antsy about this. And this is why when we look at the next year or so this is really going to be an environment that will test the mettle for central banks around the world,” Gourinchas said. “Will they be really ready to stay the course and keep their eyes on inflation and bringing it down?”

‘80s throwback?


If central banks do start easing policy before inflation is tamed, Gourinchas said there could be a repeat of the early 1980s, when the Fed, then led by Paul Volcker, backed off of monetary tightening as unemployment mounted in 1980, only to be forced into an even more punishing run of rate hikes later that year to finally crush inflation. That precipitated a long and painful recession in 1981 and 1982, then the deepest since World War Two, with an unemployment rate that eventually hit 10.8 per cent ― 3 points higher than when the Fed had taken its hiatus.

But unlike the Volcker Fed era, today's central banks do not need to apply “shock therapy” to quell inflation, but need to navigate a path to return to a neutral policy stance, he said. “This is not about inflicting unnecessary pain on the US economy or other economies,” Gourinchas said.

Neutral policy means one that is neither stimulating nor restricting the economy.

But if inflation persists and doesn't respond to withdrawal of support in a reasonable time, central banks “may have to push beyond neutral in a number of cases,” which may cause recessions. The Fed, for one, does anticipate its policy becoming restrictive by year end.

Gourinchas, a French-born University of California, Berkeley, economist who joined the IMF in January, said the path to bring down inflation without a recession is much narrower now, especially in the United States. Asked whether the United States may be in a recession already, he said the “broader discussion is that the US economy is cooling off.”

“It's cooling off significantly. It's getting to the point where in 2023, fourth quarter to fourth quarter growth is going to be 0.6 per cent. Unemployment might even rise during that period.”

The US jobless rate last month was 3.6 per cent, near a half-century low.

Gourinchas cited China's slowdown due to Covid-19 lockdowns as a major drag on the global economy. He said the IMF's forecasts anticipate a continuation of Beijing's zero-Covid policies that have led to strict lockdowns.

Chinese authorities have more recently found ways to adapt the economy so that lockdowns do not have as severe an impact on activity as they did in 2020.

Markets working

Amid a gloomy IMF outlook, Gourinchas said there were a couple of bright spots, including that financial markets have functioned well, allowing currencies and asset prices to adjust to a changing environment.

“Markets have not seized up. And there's a lot of differentiation in the market. And this is really a sign of the strength of many of the emerging market economies that have improved their policy frameworks, have improved their resilience, their buffers over the years,” he said.

Some commodity prices also have eased in response to the tightening of monetary policies, including oil and some metals prices.

“That was one of the key drivers of inflation going up,” Gourinchas said. “If these prices start coming down and they start coming down a lot that will be a key driver of inflation moderating or easing going forward. So we might be having a scenario where inflation might be coming down faster than we anticipated.” ― Reuters