Central banks should be cautious in calibrating a response to inflation

theguardian.com:

Central banks are getting twitchy about inflation. Cost of living pressures are rising just about everywhere and the relaxed mood of last autumn has been replaced by an urgency that could soon become panic.

In the US, where inflation is at highest in four decades, the latest chatter on Wall Street is that the Federal Reserve will take every opportunity to raise interest rates between now and the end of the year, seven times in all.

Inflation figures for the UK are out on Wednesday, and even though little change is expected this month from the 5.4% recorded in December, further increases are expected by the spring. Bank of England forecasts should be taken with a pinch of salt because they have been wrong for the past year, but for what it’s worth Threadneedle Street now predicts inflation to peak at just over 7%.

The Bank of England and the Fed are now getting stick for waiting so long before taking steps to rein in inflation. The US and the UK economies, it is said, are overheating as the threat from the pandemic recedes, one reason being that central banks have delayed putting up borrowing costs.

This might seem a compelling argument but the idea that the US, the UK and the big economies of the eurozone are in the middle of a rampant boom doesn’t square with the facts. The fastest growing G7 economy over the past two years has been the US, where output has increased by 1.5% on average. The next best performing country has been France, where growth has averaged less than 0.5% a year. UK output is 0.4% below its pre-pandemic level, while Germany and Italy have still more ground to make up.

So where is the inflation coming from? The answer is that prices are rising more quickly than they were because of supply-side pressures.