Profound changes in how the global economy operates, from increased protectionism to energy transition, could create greater inflation volatility and more persistent price pressures, European Central Bank President Christine Lagarde said.
Much of the developed world has struggled with a historic surge in prices over the past two years and inflation pressures have proven far more persistent than anyone predicted at the onset.
Outlining these new realities, Lagarde said the labour market is going through profound changes, energy transition creates new investment needs while a deepening geopolitical divide will lead to protectionism and supply chain constraints.
“The new environment sets the stage for larger relative price shocks than we saw before the pandemic,” Lagarde told the annual economic symposium hosted by the U.S. Federal Reserve Bank of Kansas City in Jackson Hole, Wyoming.
“Whether all these various shifts will prove to be permanent is not clear at this stage. But it is already evident that, in many cases, their effects have been more persistent than we initially expected.”
Higher investment needs and greater supply constraints are likely to lead to stronger price pressures and not all sectors will be able to absorb these, she warned.
An added complication is that workers now enjoy greater bargaining power given tight labour markets and firms have become quicker in adjusting their prices, both adding to price pressures.
While these changes could still prove temporary, central bankers need to be open to the possibility that some of them will be longer-lasting, Lagarde added.
“We will have to be extremely attentive that greater volatility in relative prices does not creep into medium-term inflation through wages repeatedly “chasing” prices,” Lagarde said.
“That could make inflation more persistent if expected wage increases are then incorporated into the pricing decisions of firms, giving rise to what I have called ‘tit-for-tat’ inflation.”