Recession dominance justifies delayed rate hikes during cost shocks
At the ERMAS conference in Cluj-Napoca, the National Bank of Romania highlighted how recession dominance and cost-push shocks theoretically justify delayed monetary policy tightening. The address surveyed research on central bank credibility and the breakdown of divine coincidence.
When waiting beats tightening
Central banks facing cost-push shocks can theoretically justify postponing monetary tightening if they hold anti-inflation credibility, according to an August 2025 study by Emi Nakamura, Jón Steinsson and Venance Riblier.
This finding aligns with Banque de France research by Dupraz and Marx.
Ricardo Reis extended the policy dominance framework of Thomas Sargent and Neil Wallace to outline five constraints on central banks facing persistent inflation.
Among these, recession dominance is particularly relevant for the National Bank of Romania: fear of inducing an excessive economic slowdown discourages policymakers from tightening as aggressively as inflation alone would dictate.
When one tool cannot fix two goals
Olivier Blanchard and Jordi Galí showed in 2007 that demand shocks allow a single interest rate tool to stabilize both inflation and the output gap simultaneously.
However, cost-push shocks break this divine coincidence, forcing painful trade-offs between price stability and growth.
Recent research by Karadi et al. examines nonlinear menu costs, while Del Negro et al. link trade-offs to inequality.
Under Jan Tinbergen's principle, achieving both goals requires matching policy instruments.
Academic cover for policy caution
Invoking recession dominance offers a convenient theoretical defense for central banks that hesitated during recent inflation spikes.
Yet leaning on past credibility to justify delayed tightening risks eroding the very reputation that makes patience viable.
Academic models cannot substitute for decisive action when cost shocks threaten to unanchor price expectations.