Some economists have signed the death certificate of inflation. They worry more about deflation that seems to have condemned many Western economies to prolonged stagnation.
The impact of COVID-19 seems to confirm the judgement of those who argue that governments and central banks should stop worrying about the return of inflation. They should instead focus on financial stability almost at all costs.
Other analysts are not so convinced that the inflation dragon that troubled so many economies in the 1970s is indeed dead. They believe that it is more likely that it is in a long hibernation but will return with a vengeance in the medium term.
A lesson learnt from the global financial crisis of 2008 is that economic austerity is not the right way to stimulate growth. Central banks soon realised that economic growth had more chance of taking off if they concentrated on their financial stability mission.
They printed money to buy the distressed debt of some countries and corporations, some of whom were not in good shape to face their future challenges. Interest rates were reduced to all-time low levels, making it easy for governments and corporate entities to cheaply refinance their debt burdens.
Yet financial markets do not seem worried by the likely consequences of a growing debt mountain. The rich-world public debt has now reached 125 per cent of GDP. Corporate debt is similarly mushrooming as investors are prepared to lend money to anyone who offers a respectable yield despite the high underlying risks.
The ECB, the Federal Reserve and the IMF have taken a dovish stance. They seem to be not so worried about the risks of inflation caused by the pumping of trillions of dollars and euros in Western economies. They believe that governments of distressed countries have a once-in-a-century opportunity to refinance their debt at much lower rates. They can even borrow new money to invest in projects that will inject growth in their economies.
Debt forbearance has become respectable even among central bankers who previously warned their governments that they should not live beyond their means by financing their deficits with debt.
If the COVID vaccine manages to accelerate the return to some form of economic normality, the rise in inflation would become a worrying probability
The balance of power is moving away from creditors to debtors as governments have a laser-sharp focus of short-term objectives of avoiding an economic depression that would destroy whole sectors of the economy and boost unemployment to unacceptable levels.
No one is expecting that interest rates will rise anytime soon to address increasing inflationary pressures. There is strong evidence that low inflation expectations are hard-wired in economic policies and financial markets.
Not surprisingly, many market analysts are forecasting that in 2021, equities are likely to continue booming as the bond market is expected to remain distressed due to central banks not being too keen to raise interest rates.
If the COVID vaccine manages to accelerate the return to some form of economic normality, the rise in inflation would become a worrying probability. The lockdown phase has meant that the money supply in most countries has expanded at unprecedented rates.
This phenomenon usually gives rise to increased inflation. The assumed stable relationship between monetary aggregates and inflation seems to be no longer valid as inflation has so far failed to raise its head. But this does not mean that this relationship is now broken. It is just more likely that the relationship is just as strong but unstable.
At present, the rate at which money circulates in the economy is low because of the pandemic. Once the medical crisis starts to abate, inflationary pressures will likely begin to build up again as the stock of money in circulation and circulation velocity start to build up.
It is risky to predict when the tide will turn. The COVID medical uncertainties remain high despite the optimistic reassurances of political leaders. If the pandemic’s economic consequences remain as damaging as they are at present, the benign interest rate regime will persist for much longer.
Governments and central banks are clearly committed to buffer their economies at all costs. They seem prepared to pay the high price of galloping inflation to achieve this aim. This trade-off is not new. This is the way that massive debt problems have been resolved for ages.
Once-in-a-century events like the pandemic can often convince the most conservative of economic strategists to rewrite economic theory that goes against the grain of conventional thinking.
We may soon need to invent new tools to address a surge in inflation in the coming years.
johncassarwhite@yahoo.com