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In a new article, Pep talk for central bankers: don’t fear the return of the bond vigilantes, Alberta Central’s Chief Economist Charles St-Arnaud writes about the dilemma that central banks are facing: cool inflation at the expense of employment, or tolerate higher inflation to allow further recovery in the labour market?

The bond vigilantes are back. The Reserve Bank of Australia this week gave up trying to control bond prices because it would have had to create too much money to offset bets that inflation is a bigger threat than the RBA thinks it is. In Canada, yields on short-term debt started to rise around the beginning of autumn, even though Bank of Canada Governor Tiff Macklem continued to insist that his goal was to orchestrate a “complete” recovery from the COVID-19 recession. Last week, the Bank of Canada blinked, ending its bond-buying program and advancing the timetable for interest-rate increases.

Many investors and analysts have been suggesting that central banks should start removing policy accommodation sooner rather than later to fight the increase in inflationary pressures. However, given the nature of the shock, the decision for central banks will not be so easy. Their levers influence demand, and most of the upward pressure on prices is coming from issues with supply. Central banks can restrain inflation, but only by sacrificing economic output in order to create slack to compensate for the inflationary pressure due to a reduction in supply. This creates a dilemma: cooling inflation at the expense of employment, or tolerating higher inflation to allow further recovery in the labour market.”

Read the full article on financialpost.com here.

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