Fighting inflation by minting new ideas

Central banks struggle to battle rising prices while a core solution might lie in what’s happening already: more innovation.

Personal trainer Antonia Kalantzi shops in Athens, Greece, which, like much of the world, faces a cost-of-living crisis.

When central bankers huddle at economic crossroads, sometimes words speak louder than actions. The U.S. Federal Reserve raised interest rates a quarter of a percentage point yesterday for the first time since the start of the pandemic to address inflation. The Bank of England made a similar adjustment today– its third in recent months. The European Central Bank, meanwhile, says it will gradually buy fewer bonds. For economists wanting bolder efforts to tame soaring prices, it has been a disappointing week.

But what may matter more than the numbers was an acknowledgment that, as the Fed put it, their “economic forecasts are necessarily imperfect descriptions of the real world.” In other words, amid the uncertainties of the pandemic and war in Ukraine, central banks are out of silver bullets.

That transparency matters. It can bolster flagging public confidence in the institutions that shepherd economic stability. More importantly, it may help break the “inflationary mindset” or “psychology of inflation” by invigorating companies and individuals to seek solutions through innovation and personal agency.

“Few are talking about the role innovation could play in this business cycle,” observed Callie Cox, an investment analyst at eToro, in a 2021 blog post. “We’ve had to re-think how we live, work, and interact with each other. And that collective re-thinking has led to a renaissance era of sorts – one that could potentially lead to productivity gains for U.S. companies and an extra boost for the economy and markets.”

Inflation in the United States, at 7.9%, is at its highest rate since 1982. A Quinnipiac University Poll survey found last month that 27% of respondents saw inflation as the country’s most urgent issue, while 59% said the economy is worsening. In Britain, where inflation is at a 30-year high of 5.5%, a Bank of England quarterly survey found last week that the public’s outlook on inflation and wages is more pessimistic than at any time since 2008.

How the public thinks about inflation can have a spiral effect. When prices rise sharply, as they have now, consumers may start spending more rapidly to avoid even greater costs ahead. That hasn’t happened yet. But as higher inflation persists, the risk grows that the public will become more focused on the short-term consequences. The result is that inflation can become self-sustaining.

Prices at the pump and grocery checkout lanes, however, may obscure more optimistic indicators. Productivity has grown by an average of 2.3% per year since 2018. According to the Bureau of Labor Statistics, productivity grew by 6.6% in the last quarter of 2021. Wages have grown 2% annually during the past two years. Those figures illustrate the opposite of what happened during the high-inflation 1970s, when productivity fell sharply and wages stagnated.

This reflects vigorous efforts by businesses to become more efficient, such as in the growth of online car sales and the estimated tens of billions of dollars saved as more people work from home. Changes like these in the way businesses operate and people work “provide reason to believe that the uptick in productivity growth over the past three years may continue,” wrote Dean Baker, a senior economist at the Center for Economic and Policy Research, last week.

Fed Chairman Jerome Powell describes his approach to inflation as “humble and nimble.” As central banks adjust their policy knobs to restore a right balance to prices, wages, and growth, those qualities hold a lesson. Stability starts on the supply side of ideas, which everyone can access.

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