Low inflation is at the heart of modern economic policy, but it does not guarantee “total security.
Most economists would now agree that inflation is “dead. The premise of low inflation is embedded in economic policy and financial markets. That is why central banks can cut interest rates to about zero and buy up mountains of government bonds. This explains how many governments were able to go on “epic” spending and borrowing to save the economy from the devastation caused by the coronavirus pandemic, and why the public debt of wealthy countries at 125% of GDP is “not too worrying” to the authorities of these states. The search for revenues has driven stock market indexes to new highs, even as the number of COVID-19 cases has skyrocketed. The only way to justify such a “booming” stock market is that it expects an economic recovery in 2021 without rising inflation, writes The Economist.
Recently, however, there have been “suspicions” that the post-pandemic world may move into an era of sharp inflation. Even the slight possibility of having to deal with a spike in inflation is worrisome, as the stock of debt is quite large. Instead of ignoring the risk, governments should take measures to avoid potential “spillover effects.
Before the pandemic, even a very “tight” job market could not raise prices quickly, but now armies of people are unemployed.
One risk is a temporary spike in inflation next year. Unlike in the aftermath of the financial crisis, the broad indicators of the rich countries’ “money supply” rose in 2020 as banks lent freely. Stuck at home, people couldn’t spend all their money. But after vaccinations and freedom from telecommuting, consumers can continue to spend money, which outpaces the ability of firms to rebuild and expand their facilities, and this can trigger price increases. The global economy is already showing contradictory trends. For example, the price of copper is 25% higher than it was in early 2020. The world must find a way to manage such a temporary spike in inflation.
Another argument about the likelihood of inflation is that there will also be more sustained price pressures. In the West and in Asia, societies are aging, provoking labor shortages. For years, globalization reduced inflation by creating a strong market for goods and labor. Now globalization is in retreat.
Burdened by the need to “pay” for aging populations and health care, politicians will favor large budget deficits.
Should we really expect inflation? A temporary spike in inflation next year is quite possible. At first, it would be a welcome sign that economies are recovering from the pandemic.
The chances of a more sustained and long-lasting period of inflation remain low. But if central banks had to raise interest rates to stop prices rising out of control, the consequences would be serious. Markets would “fall,” and companies would “falter.
While the likelihood of a spike in inflation may have increased only slightly, the consequences would have been worse. Countries should protect themselves from this risk by reorganizing their own liabilities. Governments must fund fiscal stimulus. Ministries of finance should consider the risks assumed by the central bank. There may not be a spike in inflation, but the COVID-19 pandemic showed that it is always worth preparing for the unexpected, the paper concludes.