After a pandemic, a war in Europe and the worst global inflation for 40 years, central bankers are fully justified in taking a safety-first approach. Seeking to optimise economic outcomes has taken a back seat in favour of managing risks. The big question for the summer is how officials can best set monetary policy with risk management front of mind.
To navigate the economic evidence, central bankers first need to be clear about which risks they are managing. The only ones that matter are those that affect economic activity, inflation and people’s lives. Too often, central bankers say the worst outcome would be to start a period of interest rate moves and then change their minds. This might be difficult for their personal reputation, but it carries few costs for society. If they follow the path of having to be absolutely sure before taking a decision to move rates, they will guarantee that interest rate moves are late. This can result in genuine costs for others to bear.
In the US and Europe the question is how far and fast to cut interest rates. Doing too much threatens to generate unsustainable demand, preventing a successful completion of disinflation. Too much caution, however, carries the danger that economies will revert to the pre-Covid world of deficient demand, below-target inflation and a reliance on unorthodox monetary policy such as further quantitative easing. Ironically, hawkish central bankers should strive hardest to avoid this because it is the scenario they least desire.