It’s not just inflation. The global economy today faces challenges similar to those that triggered policies of economic nationalism, the collapse of world trade in the 1920s and, ultimately, the 1929 crash and Great Depression.
This is not an overblown scare scenario for analysts, but a warning from European Central Bank chief Christine Lagarde. “We are facing the worst pandemic since the 1920s, the worst conflict in Europe since the 1940s and the worst energy shock since the 1970s,” Lagarde said on Friday, adding that these challenges combined with factors such as supply chain disruptions have forever changed global economic activity.
The similarities with 100 years ago
In a speech in Washington two days after the Federal Reserve under Jerome Powell decided on a major 50 basis point rate cut, Lagarde argued that several parallels can be drawn between the two decades of the 1920s: the 1920s and the 2020s. The decline in global trade and rapid technological developments are two of the common features of the two decades. While monetary policy in the 1920s made things worse, pushing economies into deflation and banking crises, “we are in a better position to deal with these changes today than our predecessors,” the ECB chief noted.
A century ago, he said, other central bankers learned the hard way that pegging currencies to gold and maintaining fixed exchange rates did not help in times of significant structural change. It was a tactic that pushed countries toward economic nationalism and into a deflation trap.
The extreme tests
Today, Lagarde said, central bankers have the tools they need to maintain price stability. Even in “extreme tests” of monetary policy, such as the pandemic or Russia’s invasion of Ukraine, these tools have proven effective, he noted, adding that it is rare to see such a drastic rate hike (as we have seen in 2022 and 2023) and not cause a spike in unemployment.
However, he warned that complacency is not allowed, nor are central bank measures sufficient, but governments must also avoid the disastrous measures of the 1920s. Not everyone should prepare for a long period of intense inflation volatility, learning to live with instability.