Are inflation alarm bells ringing true?

There are numerous reports in the US, EU and UK about the spectre of rising inflation, with world-renowned economists disagreeing on the short and medium-term outlook. Here, we consider the prospect of an inflationary spike and look to the last financial crisis for clues as to what will likely happen in 2022.

Inflation in most wealthy countries, especially those with their own central banks, has been low since the 1990s. They’ve mainly been able to control it through policy to combat the adverse effects of inflation or, on occasions, deflation. It should be noted that central bank autonomy from politicians has significantly assisted in the past, and it is salient to ask if that environment still truly exists today.

Constructing a post-pandemic recovery is not as easy as it sounds, but the bank-led financial crisis a decade ago that still lingers in many countries does provide some guidance. For one thing, like the last crisis, the cost of rebuilding a pandemic ravaged economy is staggering. A 2018 study by America’s Federal Reserve Board found that the 2008 financial crisis had cost every single American approximately $70,000 – something in the order of $2.5trillion. Joe Biden’s Covid Relief Bill has just been passed at $1.9trillion. In 2008/9, quantitative easing measures aimed to do two things other than saving the banks – stimulating the economy to avoid job losses and therefore fight off deflation.

Today, policymakers are looking at a completely new challenge.

Will they allow short-term inflation (and ditch firmly entrenched economic beliefs that have managed the cyclical recessionary storms of recent decades) – or look at mixing in radical new policies in the fight for order between economic activity, debt burdens, employment and savings/investments?

The world’s economic experts are divided. Harvard University’s Kenneth Rogoff (Professor of Public Policy and Economics at Harvard University) thinks that markets are probably too concerned about short-term inflation risks for 2021 and not the longer-term outlook. Axel Alfred Weber, the German economist, professor, and board member of Swiss bank UBS Group thinks that we should be more worried that expansionary fiscal and monetary policies exercised in the US, EU and Britain – could trigger higher inflation in the near future.

Robert J. Barro is an American macroeconomist and considered one of the founders of new classical macroeconomics. He disagrees with Weber and warns that the US Federal Reserve is overconfident of its ability to maintain low long-term inflation expectations but is again not concerned with short-term pressures. (1)

For all of the opinions, there is one pressure though that trumps all others right now. Policymakers face the immediate battleground of employment over short-term price stability. Then, of course, there’s the wild card – will this pandemic really come to an end and if so, when.

If you’ve been reading about the threat of hyperinflation, especially in America, be assured that such an event is about as likely as Brexit bringing all the promised sunlit uplands imaginable. It won’t. But these rumours are damaging and they do sometimes have a habit of influencing real-world events. As Peter Coy at Bloomberg says – “talk that the US is going the way of Zimbabwe or Venezuela is bunk—but bunk can move markets and influence policy.” (2)

The pandemic has, of course, caused economies around the world to be dramatically ‘chilled’, but as lockdowns come to an end, there is an expectation that additional savings will suddenly overheat a bottleneck supply chain – causing an inflationary spike. As the UK makes strides towards unlocking from the pandemic, inflation accelerated in January. Economists say it is the first step toward a significant increase. If that means bringing inflation up towards the target rate of 2 per cent, then all well and good. But will it go further?

Given the circumstances, there’s a strong possibility that competing economic influences decide the outcome. James Smith, an economist at ING, said he expects inflation – “to reach 2% by the end of the year, before dipping again below target in 2022. It’s an outlook that doesn’t justify the BOE cutting interest rates below zero, but “also probably won’t warrant rate hikes” or the withdrawal of stimulus until “2023 at the earliest.” (3)

The outlook for the Eurozone is that inflation will hold steady as expected and then make for a temporary but sharp spike in consumer prices in the coming months (4). However, Biden has just caused world shares to dip as the US Senate’s $1.9 trillion stimulus bill put fresh pressure on treasuries and tech stocks with lofty valuations, raising inflation jitters, not just in the USA, even further.

One effect of inflation is that it causes spending and investing, which directly strengthens the jobs market. Conversely, it erodes purchasing power. Both have the power to create feedback loops and cause real problems.

These two basic outputs have different effects depending on who you are. For those in midlife and beyond – inflationary pressures are in their top three fears behind truly scary events such as serious illness and memory loss. (5) It also tends to lead to lower unemployment for the younger generations, although not always (think 1970s).

High inflation is usually associated with a slumping exchange rate. However, this is generally a case of a weaker currency leading to inflation, not the other way around. For instance, Britain’s weak exchange rate does mean it is globally competitive, but as it imports more than it exports, inflation can quickly arrive through the backdoor.

The IMF has predicted inflation in the US to rise to 2.24 per cent in 2021. Fitch Ratings has predicted US inflation will tick higher looking further out. “Long-term US inflation risks have increased. The coronavirus pandemic has exacerbated concerns about inequality, which could lead to policies that boost wages. De-globalisation will add to price pressures.” (6)

In the UK, economists more generally see an initial inflationary spike and then a cool-down in 2022. However, the UK has some particular problems – Brexit being one of them. That has caused the economy to lose some £200bn in GDP over the four years since the referendum, and this £50bn annual hit to the economy (currently being covered by the pandemic) is expected to double over the following decade at least.

Lower economic activity is likely to lead to lower employment and quite possibly more drastic measures to force savings out into the open – such is the spectre of negative rates being hinted at by the Bank of England and IMF. (7)

In the EU, the Eurozone had struggled to keep inflation on target for some time but is now seeing signs of inflationary pressures. This may well be seen as positive for now. Still, in the medium term, inflation looks set to fall back again, and negative interest rates will remain.

On balance, it appears that in the USA, EU and UK there will be a short-term inflationary spike, followed by a cooling of economic activity and therefore reduced inflation in the short to medium term.

In the UK, negative rates are now a 50/50 bet for next year and given the damage that Brexit is forecast to do (that cannot be undone), it’s a fair gamble to assume that this radical policy may well be used for the first time in the 327 year history of the Bank of England.

 

Graham Vanbergen is a publisher, author (Brexit – A Corporate Coup D’Etat), communications strategist and journalist. 

References

  1. Project Syndicate – Is Inflation Alive?
  2. Bloomberg BusinessWeek – US Hyperinflation
  3. Bloomberg – UK inflation
  4. Nazdaq News – Eurozone expected inflationary spike
  5. The Midlyfe Project – Top 10 fears of later life
  6. Fitch Rating – medium-term upward pressure
  7. The Times – Safe to take interest rates negative