The post-pandemic economy has thrown central bankers into uncharted territory. While their core mission—keeping prices stable—hasn't changed, the tools and assumptions that worked for decades no longer suffice. Structural forces including geopolitical fragmentation, technological disruption, aging populations, and climate change are rewriting the rules of monetary policy.
Since 2020, supply shocks have become both more frequent and more stubborn. This marks a sharp break from the Great Moderation era (1984–2007), when inflation stayed low and predictable, GDP growth was steady, and globalization kept trade humming. Central banks could set interest rates based on well-established economic relationships, confident that credible commitments to low inflation had anchored expectations.
The 2008 financial crisis cracked that confidence. It revealed that price stability alone didn't guarantee financial stability—asset bubbles could still form even with inflation in check. The years that followed, from 2009 to 2019, extended some Great Moderation traits but with inflation often undershooting its 2% target and growth disappointingly weak, fueling fears of secular stagnation. Central banks resorted to unconventional tools like quantitative easing and forward guidance as short-term rates hit rock bottom.
Then came COVID-19. The pandemic and its aftermath—supply chain breakdowns, energy crises, trade wars, and geopolitical conflicts—have not been a series of isolated shocks, but rather a structural transformation of the global economy. Key tailwinds that kept inflation low for 40 years are now reversing. The integration of hundreds of millions of workers from China, India, and the former Soviet bloc into the global labor force, along with the IT revolution, enabled outsourcing, offshoring, and efficient global supply chains. That kept goods prices down and weakened worker bargaining power.
Economists Charles Goodhart and Manoj Pradhan argue that those days are over. Aging populations will drive up healthcare costs, while falling birth rates, anti-migrant policies, and a shift from efficiency to resilience in supply chains will put persistent upward pressure on prices. Export controls and technology restrictions add another layer of friction. Central banks will find it much harder to keep inflation in check.
Fiscal discipline and central bank independence were hallmarks of the Great Moderation. Today, soaring public debt and large deficits across the advanced world are pressuring central banks to accommodate government financing needs. Fiscal dominance is no longer a theoretical risk—it's a real threat to the Federal Reserve and its peers.
Two other dangers loom. First, persistent above-target inflation risks unanchoring expectations, which would amplify price volatility and make future disinflation far more painful, potentially requiring a recession. Second, as Banca d'Italia Governor Fabio Panetta notes, monetary transmission channels are evolving in unpredictable ways. AI and digital banking could speed up the pass-through of rate changes, while an aging population may blunt the impact on household spending. Geopolitical fragmentation could make investment decisions less sensitive to interest rates.
Central bankers must now embrace flexibility, adaptability, and forward-looking decision-making. The old playbook is obsolete. The new one is still being written.
