IMF chief: Central banks must balance inflation caused by rising energy prices with weakening demand

Central banks must be prepared to tighten monetary policy to avoid an inflationary spiral if energy price shocks caused by the war continue, but they must also monitor weakening demand, which would be an argument against raising interest rates, said International Monetary Fund Managing Director Kristalina Georgieva.

Georgieva, speaking at an event ahead of the annual meetings of the IMF and World Bank next week, said central banks could keep interest rates unchanged with only a modest rise in inflation if the ceasefire in the war with Iran holds and the disruption to oil supplies is short-lived. That would effectively mean easing monetary policy, Reuters reported.

She warned central banks, which have been slow to respond to inflation after the coronavirus pandemic, not to rush to raise interest rates, but to monitor the data carefully.

“Be careful, focus on the conditions, because if you tighten policy too soon and unnecessarily, you stifle economic growth,” Georgieva said. “And then demand can weaken. And then you go from a supply-side shock to a supply-side and demand-side shock. And that can get very bad.”

The war in the Middle East, which began on February 28, has disrupted global shipping and caused oil prices to jump 50 percent, while the IMF warned this week that the war will lead to higher prices and slower growth, regardless of when it ends.

Much will depend on how long the war lasts and how much damage is left behind, Georgieva said, adding that markets had expected major central banks to tighten their policies.

She warned that there is a risk that inflation expectations will get out of control and trigger a costly inflationary spiral.

She said that short-term inflation expectations had increased, but that long-term ones had not changed, adding: "That is very good and very important."

IMF officials are working with countries to help them design fiscal support packages with time-limited measures, to ensure they remain temporary, while emphasizing that fiscal and monetary policies must not work in opposite directions, she said.

“Adding deficit-financed stimulus at this point would only increase the burden on monetary policy,” she said. “That would be like driving with one foot on the gas and the other on the brake — not good.”