MNI: Fed's Brainard: Supply Shocks Call for Tighter Policy
A long series of supply shocks call for tighter monetary policy to keep inflation expectations anchored, and longer run shifts in demographics, supply chains and Earth's climate may mean inflation will be more volatile in the future, Federal Reserve governor Lael Brainard said Monday.
In a speech prepared for the Bank for International Settlements annual conference in Basel, Switzerland, Brainard reflected on lessons from high inflation as a result of Covid-19 and Russia's invasion of Ukraine.
"The experience with the pandemic and the war highlights challenges for monetary policy in responding to supply shocks. A protracted series of adverse supply shocks could persistently weigh on potential output or could risk pushing inflation expectations above target in ways that call for monetary policy to tighten for risk-management reasons," she said.
"More speculatively, it is possible that longer-term changes — such as those associated with labor supply, deglobalization, and climate change — could reduce the elasticity of supply and increase inflation volatility into the future," she said.
The standard monetary policy response to supply shocks is to look through them, she noted. But if supply shocks lower potential output such that the economy is operating above potential, "monetary policy tightening is necessary to bring demand into alignment with the economy’s reduced productive capacity," she said.
"Importantly, and separately from the implications for potential output, monetary policy should respond strongly if supply shocks risk de-anchoring inflation expectations," she said.