Bankers are handcuffed by old narratives in US

In the space of a few short months, the prevailing narrative on US inflation has veered from “It’s transitory” to “We have a problem.” The Federal Reserve took another step towards acknowledging this, raising its policy rate by 50 basis points and leading investors to expect a faster pace of tightening from now on. That’s fine, you might say, the facts have changed — and to paraphrase John Maynard Keynes, when the facts change, you change your story. What’s interesting is that the story has changed more abruptly than the facts.
Economic policy seems especially susceptible to a certain dynamic. Ideas get fixed too firmly and for too long, so when they’re forced to change, the shift is violent. Narratives drive decisions, and stories shape events, rather than the other way round. The new account of inflation is an arresting example.
Yale’s Robert Shiller discussed the phenomenon in his 2019 book “Narrative Economics.” Writing before Covid-19, he proposed an analogy with epidemics. Frequently recurring infections include real-estate booms and busts, stock market bubbles and crashes, “boycotts, profiteers and evil business” and “the wage-price spiral and evil unions.” These and other tales can go viral, guiding both behavior and policy, directly or indirectly — validating themselves perhaps for years until they give way all at once to a new story.
Such epidemics certainly aren’t confined to finance and economics, as anybody glancing at Twitter can see, but they’re especially powerful in the economic domain because expectations are so central to economic decision-making. The pivot in thinking on inflation wasn’t a timely course correction made in light of new data: In recent years, more has been at issue in debates over monetary policy than the latest figures on prices, output and jobs. Systems of claims amounting to different views of the world have been in contention. One came to dominate, and for longer than you’d expect, it recruited every new particle of data to its side. Without giving way, it was gradually undermined by news that didn’t quite fit. All of a sudden, it no longer worked, and a new narrative took its place.
The old story led to mistakes. The new one might well do the same.
In March, inflation surged to 8.5%, the highest since 1981. The cause was and remains an excess of demand over supply. The question is how much of this imbalance is due to higher demand, driven partly by fiscal and monetary policy, and how much is due to interrupted supply, caused first by the pandemic shutdowns and then, since February, by sanctions on Russia. Without knowing the answer, we can’t easily say how policy should respond.
The old story emphasized an edict from standard macroeconomics: If temporary supply interruptions are the main thing, you shouldn’t brake the economy by restricting demand, which will cut output further and raise unemployment. It’s better to put up with the transitory rise in prices induced by a supply shock and wait for the blockages to clear.
Long before Russia attacked Ukraine and the US and its allies responded by choking its energy exports, inflation had moved higher than most analysts had expected. Prices were rising in sectors not directly impacted by the shutdowns. Attention was turning to signs of tightness in the labour market, and wages were edging higher as well.

—Bloomberg