An old axiom in financial markets borrowed from the military is that “policymakers always fight the last war.” The conclusion they drew from the GFC, for example, was to provide as much stimulus as possible, as early as possible, and not worry about the consequences. The result was that when the pandemic rolled around, policymakers did exactly that and generated rates of inflation not seen since the 1980s. Having now learned the lessons from that experience, and assuming they follow the same pattern in the face of today’s oil shock, we should expect fiscal policymakers to engage in more targeted relief to struggling households, in smaller doses, spread out over time, and in many cases focused on demand suppression rather than near-term stimulus.
Central bankers, meanwhile, are also likely to respond to the inflation threat much quicker and more vigorously than they did following the pandemic, having discovered just how much the public really hates inflation (and who inevitably gets the blame). As we head toward yet another unfolding inflation shock, in this Economics Weekly, Richard de Chazal discuss how central banks view inflation, what their likely response will be today looking through that prism, and why they also should acknowledge that inflation was already accelerating even before the start of the war.