The winter of our discomfort

CAMBRIDGE — The start of 2022 has been marked by a deepening sense of unease, and not just within governments as they confront challenges relating to health, the economy, geopolitics and, in some cases, national and financial security. Households and a wide range of companies are feeling it, too. All have been pushed out of, or kept away from, “normality” much longer than expected.

COVID-19 is a relevant factor, of course, but it has been joined by several other developments, from rising geopolitical tensions and inflation to household financial vulnerability, labour shortages and market volatility.

The Omicron variant has driven COVID-19 infections to levels that would have been deemed very dangerous with previous dominant variants such as Alpha or Delta. Fortunately, Omicron has proven to be less severe, with new cases much less likely to lead to hospitalisation or death. Indeed, many hope that Omicron eventually will allow a transition from the highly disruptive pandemic of the past two years. In this scenario, the coronavirus would become endemic but relatively manageable, especially if we adjust how we do certain things.

Nonetheless, Omicron is still a major source of discomfort for now. Not only has it forced many people to self-isolate after testing positive, which has added to labour and supply disruptions and caused income losses among the most vulnerable segments of society. It also has led to different countries adopting different COVID-management strategies, amplifying the prior lack of sufficient coordination globally.

Vaccine inequality persists as a particularly serious problem, because the door will remain open to the emergence of new variants until the global population has been generally immunised. Similarly, China’s zero-COVID policy could fuel new rounds of supply-chain disruptions, further adding to the uncertainty.

Such disruptions would create more upward pressure on prices just as inflation has become the number-one public concern in the United States. What started as a contained price shock for many has evolved into something much broader. As a result, consumer sentiment has declined and household vulnerability is increasing, particularly for already-challenged segments of the population.

The persistence of labour shortages has spillover effects in both directions. While it contributes to inflationary pressures as companies pass higher labour costs on to consumers, it also helps boost wages, following a multidecade erosion in real earnings. This second effect is especially important for those at the lower end of the income spectrum, whose wage gains have lagged behind productivity growth for many years.

Another source of discomfort is market volatility. So far this year, there has been a pronounced increase in unsettling asset price swings, because geopolitical and economic concerns have been turbocharged by the growing realisation that major central banks are on the cusp of a major policy change. After years of providing massive support for asset prices, and having made a major error by insisting until the end of November 2021 that inflation was “transitory”, the US Federal Reserve (Fed) is being forced to pivot hard to a less accommodative policy stance. It now must react forcefully to the high inflation that it previously failed to understand and address — and thereby allowed to become more entrenched.

This withdrawal of monetary-policy accommodation — which included highly repressed interest rates and a record level of monthly liquidity injections for most of 2021 — risks triggering a notable tightening of what had become unprecedentedly loose financial conditions. The risks to livelihoods will be particularly pronounced if a behind-the-curve Fed is forced into an excessively contractionary policy.

This could mean a three-pronged approach in which the Fed, within a very short span of time, not only ends monthly asset purchases but also hikes interest rates and starts to unwind its massive balance sheet. This would come after a period when the Fed has been exceptionally supportive of asset prices, both directly and indirectly, by continuously repressing volatility and encouraging more risk taking. If it stumbles again on its policy responsibilities, it could cause an otherwise avoidable recession, inflicting a double blow on society of higher inflation and lower incomes.

Finally, there is the added discomfort caused by geopolitics. Heightened Russia-Ukraine tensions are adding to the uncertainty and inflationary pressures. With most assessments of the situation unable to predict confidently either an open military conflict or a durable diplomatic resolution, many feel stuck in the muddled middle. And a similar phenomenon is playing out in the Sino-American relationship, albeit to a lesser degree.

Each of these developments would cause considerable uncertainty on its own. Together, they have created a deep, widespread discomfort, increasing the probability of errors and misjudgements at every level of society. While most of today’s problems can be overcome as standalones, recovery from a large combination of them would be difficult.

In the past, a robust mix of resilience, agility, and optionality has been essential for sound decision-making under unusually uncertain circumstances. We must double down on all three, while also ensuring that we do more to protect the most vulnerable segments of our societies.

Mohamed A. El Erian, president of Queens’ College, University of Cambridge, is professor at the Wharton School, University of Pennsylvania, and the author of “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse” (Random House, 2016). Copyright: Project Syndicate, 2021. www.project-syndicate.org