Monetary policy: Although central banks can generally look through transitory inflation pressures and avoid tightening until there is more clarity on underlying price dynamics, they should be prepared to act quickly if the recovery strengthens faster than expected or risks of rising inflation expectations become tangible. In settings where inflation is rising amid still-subdued employment rates and risks of expectations de-anchoring are becoming concrete, monetary policy may need to be tightened to get ahead of price pressures, even if that delays the employment recovery. The alternative of waiting for stronger employment outcomes runs the risk that inflation increases in a self-fulfilling way, undermining the credibility of the policy framework and creating more uncertainty. A spiral of doubt could hold back private investment and lead to precisely the slower employment recovery central banks seek to avoid when holding off on policy tightening. By contrast, monetary policy can remain accommodative where inflation pressures are contained, inflation expectations are still below the central bank target, and labor market slack remains. The unprecedented conjuncture makes transparent and clear communication about the outlook for monetary policy even more critical.

Rises in Inflation, High Uncertainty

Even as employment rates remain below PRE pandemic levels—suggesting substantial labor market slack—headline inflation rates have increased rapidly in the United States and in some emerging market and developing economies in recent months, although there are differences in the extent of pressures across countries. In some countries in sub-Saharan Africa and the Middle East and Central Asia, food prices have increased significantly amid local shortages and the rise in global food prices. Core inflation—which removes the influence of food and energy prices—has also risen in many countries, but to a lesser extent. To a large degree, the increase in inflation reflects a combination of pandemic-induced supply-demand mismatches, rising commodity prices, and policy-related developments (such as the expiration of last year’s temporary value-added tax cut in Germany and the increase in the shelter component of US consumer prices as rent and mortgage moratoriums expire in some.

A key element of central banks’ policy frameworks is the Phillips curve relationship. This describes a trade-off between low slack (for instance, low cyclical unemployment) and high inflation.1 In the Phillips curve, the inflation process is also related to cost-push shocks driven by supply disturbances and to long-term inflation expectations. As inflation-targeting regimes have become more prevalent, long-term inflation expectations have played a greater role in explaining inflation outcomes.

1. Based on your results of inflation in Bahrain, can you explain how the central bank of Bahrain conducted monetary policy to combat inflation?
2. In some countries in sub-Saharan Africa and the Middle East and Central Asia, food prices have increased significantly amid local shortages and the rise in global food prices. Explain.
3. Assess the impact of the global increase in prices due corona pandemic on the economy of Bahrain. How do you explain the linkages between the global economy and the economy of Bahrain?