Jay Powell, Chair of the Federal Reserve, recently delivered a speech at the Jackson Hole Economic Symposium that bordered on a celebration. Powell expressed confidence in the Federal Reserve’s efforts to combat inflation, highlighting that inflation has significantly declined, labor market conditions are easing, and supply constraints have returned to normal. With cautious optimism, Powell suggested that the U.S. economy might achieve the desired 2 percent inflation target while maintaining a robust labor market, given a careful reduction in policy restraints. He painted a picture of an economy on the verge of stability, describing a future where the U.S. could navigate back to low inflation rates without sacrificing employment levels. Powell’s tone suggested that “happy times” might be on the horizon.
This outcome is notably better than many, including Powell himself, had anticipated two years ago. The achievement of reducing inflation with minimal impact on the real economy is indeed a pleasant surprise, particularly with unemployment at 4.3 percent, which remains low by historical standards. However, while Powell’s narrative is encouraging for the U.S., the economic outlook in other parts of the world, such as the Eurozone and the United Kingdom, is far less positive. Even in these regions, lower interest rates and stronger demand could eventually emerge, but the path forward is less certain.
One of the key reasons Powell attributed to this success is the stability of long-term inflation expectations, which the policy of “flexible average inflation targeting” aimed to achieve. Powell also acknowledged that some of the progress was due to favorable conditions, particularly with the labor supply. However, the story of how inflation has been managed, especially in the U.S., is far from straightforward and not without significant lessons. Mistakes were made in understanding the economic impacts of the COVID-19 pandemic, and further errors occurred when attributing the inflation surge solely to unexpected supply shocks. Demand-side factors played a substantial role, and it is crucial for central banks to learn from these mistakes, even if the results this time were less damaging than expected.
The inflationary episode should be viewed not as a mere increase in inflation rates but as a shock to the overall price level. Between December 2020 and 2023, the consumer price index in the U.S. and the Eurozone rose by nearly 18 percent, while in the UK, it surged by 21 percent. These figures are significantly above the supposed target of around 6 percent over three years, explaining why many households feel the pain of a “cost of living crisis.” Moreover, this represents a permanent step change, not a temporary fluctuation. Under inflation-targeting regimes, such shocks are considered bygone, but that does not mean their effects will quickly fade from memory.
While the Federal Reserve celebrates inflation control, other economies grapple with lasting price hikes and economic instability.
Temporary supply shocks do not, by themselves, cause permanent price level increases. For this to happen, demand must accommodate and often drive such jumps. In this case, the fiscal and monetary responses to the COVID-19 crisis were aggressively expansionary, treating the pandemic as if it were another Great Depression. Consequently, when the crisis receded, demand surged. At a minimum, this amplified the overall price increases seen in scarce products and services and, arguably, fueled much of the demand that led to these price hikes.
Economists like Tim Congdon, a British monetarist, had warned about these dynamics. Referring to Irving Fisher’s “equation of exchange” (MV=PT, where M is money, V is its velocity of circulation, P is the price level, and T is the volume of transactions), Congdon pointed out that between late 2019 and 2020, the broad money supply (M3) relative to GDP rose by 15 percentage points in the Eurozone, 17 points in the U.S., 20 in Japan, and 23 in the UK. This represented a global glut of money supply. As Milton Friedman would have argued, such conditions make subsequent “supply shortages” and rising price levels almost inevitable. Expansionary fiscal policies further intensified these effects. While some argue that monetary aggregates are less relevant in normal times, recent studies, such as those from Bruegel and the Bank for International Settlements, suggest that in volatile conditions, money does indeed matter for inflation. Hence, large monetary expansions or contractions should never be ignored.
The massive monetary expansion seen during the pandemic was largely a one-time event, and since 2020, the ratios of money supply to GDP have been allowed to fall back as nominal GDP increased. Monetarists would argue that inflation stabilization was inevitable under these conditions, as has been observed. This outcome was supported by stable inflation expectations and, in some regions, immigration. However, the significant increase in price levels resulted from the interaction between post-COVID supply chain disruptions, the war in Ukraine, and strong demand. This does not necessarily mean that the strong demand response was a mistake; weaker demand could have led to severe economic and social consequences. Nonetheless, such alternatives need careful examination, as large shocks are likely to happen again.
The question now is whether inflation will stabilize in the long run. Additionally, there is uncertainty over the extent to which the recent rise in interest rates will be reversed. Some argue that we might be entering an era where interest rates remain permanently higher, which could mean that the fear of the lower bound on interest rates is over.
The resilience of most economies, despite the tightening of monetary policy, suggests that this could indeed be the case. However, this poses a potential risk to future financial and fiscal stability, as new debt will be much more expensive than old debt. Factors like an aging population, lower savings rates, fiscal pressures, and the substantial investment needed for climate initiatives may combine to make both public and private debt more costly consistently. If so, the prospect of “high for longer” interest rates could prove to be a significant challenge.
The inflation-targeting framework has been tested by two major crises: the global financial crisis and the COVID-19 pandemic. It has survived, but barely. However, more severe shocks could be just around the corner. While the Federal Reserve may celebrate a hard-earned victory, economies like Spain, where inflation continues to surge and citizens grapple with increasing costs, remind us that the global economy is far from stable. The lessons of the past few years must be heeded because the next economic storm may already be on the horizon.
Differences in Inflation Between Spain and Morocco: A Tale of Two Strategies
While inflation rates in many European countries, including Spain, have remained stubbornly high, Morocco has managed to maintain relatively low inflation levels despite being geographically close and similarly exposed to global economic pressures. The stark contrast between Spain’s persistently high inflation and Morocco’s lower rate highlights the impact of divergent economic policies and strategies in response to the same global challenges.
Morocco’s success in keeping inflation under control can be attributed to a combination of proactive monetary policy, effective regulation of key sectors, and a relatively stable energy strategy. The Moroccan central bank, Bank Al-Maghrib, has implemented a cautious approach to monetary policy, tightening interest rates when necessary to curb inflationary pressures. Additionally, Morocco has benefited from a more controlled and diversified food supply chain, which has helped to mitigate some of the price shocks experienced by its European neighbors. The Moroccan government has also maintained subsidies on essential goods and energy, shielding consumers from the full impact of global price increases.
Spain, on the other hand, continues to grapple with inflationary pressures that show no signs of abating in the short term. The Spanish economy has been heavily affected by rising energy prices, a direct result of the war in Ukraine and subsequent disruptions in European energy markets. Spain’s reliance on imported energy, particularly natural gas, has exacerbated its inflationary problems. Moreover, the rapid post-pandemic recovery in demand, coupled with supply chain disruptions, has pushed up prices across a wide range of goods and services.
While Morocco has managed to cap energy price increases through subsidies and regulatory measures, Spain has faced more challenges in controlling energy costs due to its integration within the broader European energy market, which has been volatile and driven by external geopolitical factors. Spain’s inflation has also been affected by a tight labor market and rising wages, which have added upward pressure on prices, unlike Morocco, where wage growth has been more contained.
Furthermore, Spain’s fiscal policies have not had the same dampening effect on inflation as Morocco’s. The Spanish government’s fiscal response to the COVID-19 pandemic involved significant spending measures, which, while supporting economic recovery, have also contributed to rising inflation. Meanwhile, Morocco’s more conservative fiscal stance, combined with its proactive monetary measures, has allowed it to keep inflation in check despite similar external pressures.
This divergence underscores the complexities of managing inflation in a globalized economy where local policies and economic structures play a critical role. Spain’s high inflation rate, with little prospect of falling soon, contrasts sharply with Morocco’s relative success in maintaining stability, illustrating how different approaches to monetary policy, fiscal management, and energy regulation can lead to vastly different outcomes in neighboring countries facing similar global challenges.
