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Small Case 2: Viewpoint “[Economists assume] a stable relationship between aggregate demand, aggregate supply, wages, and prices......

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Economics

Small Case 2: Viewpoint “[Economists assume] a stable relationship between aggregate demand, aggregate supply, wages, and prices... But... these relationships are anything but stable. For example, it is unclear how the labour supply will evolve as pandemic-related distortions fade. This makes it extremely difficult to judge the threat of a price-wage spiral. [So] central banks are putting less weight on their forecasts and more on actual inflation... without the conviction of a model... it’s unlikely that central banks will be able accurately to flag a peak in rates—much less a pivot—in advance... since monetary policy operates with a lag, putting more weight on actual inflation... raises the risk of over-tightening... if central banks don’t know how far to raise rates to squeeze out inflation, then there’s something wrong with our... thinking about what drives it." Neil Shearing, Capital Economics [Source: Moneyweek, November 25, 2022, Issue 1131] Q 1. Why does monetary policy operate with a lag? Q 2. Why are central banks putting less weight on their forecasts and more on actual inflation?

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