We ought to acknowledge that an economy requires a proportional rate of inflation (“walking inflation”) to grow. Moderate inflation is a signal of a dynamic economy. The logic is simple: one’s expense means another’s income in economic circulation. What an economy should avoid is “hyperinflation” (where inflation is really high) and “stagflation” (where there is inflation in rather-stagnant growth). Both have disruptive effects on economic movement.

The US Federal Reserve’s Jerome Powell has hiked the interest rate by 150 basis points so far this year. The Fed has engaged in an extreme pendulum to tame the inflation that was once projected to be transitory. Yet US inflation has not slowed. Theoretically, until it gets more conducive, we might expect further monetary tightening. This approach, unfortunately, is alarming not only for the US domestic economy but also for emerging markets. Among other risks, the most obvious is the risk of capital flight.

Some might believe that inflation is a logical consequence of the domestic macro-policy measures that have been taken to outwork the pandemic-induced economic crisis. There have been major policy instruments used, ranging from quantitative easing (in some extreme cases, “helicopter money”) to an expanded government deficit. The rationale for these was to “inflate” the double-edged pressure on supply and demand due to various pandemic restrictions.

The postulate of why inflation happens is that there is too much money to chase too few goods. There are two dimensions: first, the “demand-pull inflation” vis-à-vis the money-in-circulation variable. While there are excess monetary resources available, the productive capacity might be unable to catch up with consumers’ desires to consume. The demand pressure may not necessarily be the dominant cause of today’s inflation, though it is still worth being accounted for.

The second dimension is “cost-push inflation”, the pressure on production costs that affects consumer prices. This aspect urges the analytical focus on the supply disruptions, in many ways. Today, the shocks come from various angles of attack, including the pandemic-restriction effects and the economic consequence of the Russia-Ukraine conflict, both spread globally.

Central banks’ mandate to maintain domestic price stability gets more complicated. US congresswoman Ayanna Pressley acknowledged that the root cause of US inflation was the supply-chain crisis that was outside the Fed’s control. She said, I quote: “we need a more sophisticated toolkit for the error we are in to heal our economy and tackle inflation responsively”.

Domestically, Statistics Indonesia (BPS) recorded an inflation rate of 4.35 percent year-on-year (yoy) in June, higher than in May and becoming the highest since June 2017. We received the signal to be alert but not to be alarmist.

Bank Indonesia (BI) once stated that the board would not raise the BI 7-day reverse repo rate (BI-7DRR) until there was a sign of inflationary pressure. We may indicate that BI will likely need to increase the BI-7DRR soon. The measure is expected to dampen inflation expectations to achieve price stability. On the other end, the rate adjustment could cause an unintended impact on the economic recovery trajectory.

BI’s soon-to-be interest hike has been well-calibrated with other measures. BI started the liquidity policy normalization through a gradual rise of reserve requirement (GWM) beginning June 2022, considerably for banks’ capacity for extension of credit and participation in the sovereign economic recovery program. By doing so, the central bank preserves adequate room for recovery.

The pandemic-induced economic crisis has taught us that solely adjusting the policy rate does not serve the macroeconomic goal of robust and sustainable economic development. Policy innovation is also key. Entering the inflationary economy within a difficult period, that lesson learned is still relevant. Fine-tuning the policy rate should be reinforced with macroprudential measures and payment system stability. Inclusiveness and efficient productivity as endogenous components of economic growth matter more than ever.

Calibrating multiple instruments within the “policy mix” framework is necessary, especially with the risk of stagflation ahead. Not only that, the expectation of inflation must be duly-managed, but well-functioning economic intermediaries and efficient payments are essential to ensure stability. From the government side, sectoral and structural policies are foundational to resolving supply disruptions.

Within the macroeconomic policy-mix framework, monetary and fiscal policies also have to be calibrated. While monetary policy has to be tightened due to inflation, fiscal policy needs to buffer against the impact of the monetary tightening measures. Both are required to work together holistically, although the manner could be very different.

Beyond technicality, global collaboration is the prerequisite to overcoming the inflation problem. When each central bank as a collective agent in a country acts rationally, but with its particular preferences and in the absence of coordination, it can – if not always ­–result in suboptimal outcomes in a broader context: our global environment. Without each other working together, correcting the overlapping global crises of supply chains and high inflation would be impossible.

While the global economy and geopolitical situation are currently not ideal, we all should eagerly pursue collective solutions. Approaching the Group of 20 Summit in November, the theme of recover together, recover stronger should be promoted louder among the world’s largest economic leaders and the rest of the world.

There were times when monetary policy was about disciplining price expectation (i.e. via money modulation). Today, the aggressive monetary policy response to contain inflationary pressures may increase the global stagflation risk. Central banks must not stop evolving and should be creative. Against a multitude of challenges, we shall give a turn for the policy mix choice.

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The writer is a legal adviser at Bank Indonesia. The views expressed are his own.