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Ekonomiskā vide - 2021 03 03
inflation | coronavirus

Inflation – logical stabilisation of economy or relapsing into debt?

Inflation – logical stabilisation of economy or relapsing into debt? Photo: Mika Baumeister, Unsplash

Inflation is expected to rise in the coming months, but there are many questions about its long-term prospects. Should the money printing machines continue to run at full speed? Is it perhaps time to review property and stock prices? What footprint will the Covid 19 crisis leave on the economy?

The pandemic has had an uneven impact on the economy, with some sectors being hit harder while others have been virtually unaffected. Consequently, certain groups in the population have felt the decline in income and purchasing power. Unemployment has also increased.

Given the level of support and vaccination, purchasing power for certain groups will gradually recover, although very slowly in the coming years. Inflation is expected to rise at least in the coming months. As for the longer-term outlook, there are many questions. 

Money printing and sustainable debt

In recent years, ultra-low inflation has been one of the hot economic topics, discussed primarily by central banks. This situation allowed the money printing machines to run at full speed to prop up the economy.

A resurgence of inflation would be a logical consequence of economic stabilisation and monetary expansion.

The fixed income market is forecasting inflation above 2% and just above 1% in the US and the Eurozone, respectively. This is still a low level. Rising inflation, however, will raise questions for economy and also for the financial system in terms of sustainable debt and valuations of many assets, such as stocks and real estate prices.

Are these changes here to stay?

In retrospect, inflationary processes are difficult to assess because of structural changes as well as the Covid-19 crisis. The low inflation of the last 20 years hardly reflects weak demand, because before the pandemic, some countries had the lowest unemployment rates in half a century.

Changes in consumption and production patterns, as well as the impact of Covid-19, can pull inflation up as well as down. At this point, determining whether the observed changes in the global economy are temporary or will be permanent is difficult. Some highlights:

  • Since the 2008 financial crisis, central banks have spent about EUR 18 trillion globally. That is an increase by almost 450%, however, the link between rising asset prices and higher demand/consumption is weak, possibly due to economic inequality and aging populations.
  • The Covid-19 crisis has contributed to a visible imbalance between supply and demand, especially for services. Normally, this leads to falling wages and prices, and thus to inflationary pressures. However, two factors complicate the situation. First, the uncertainty of GDP data. Second, increasing digitalisation and remote working, which raises the question of the balance between new supply and demand.
  • Manufacturing and supply chains have proven to be remarkably resilient. However, as the services sector recovers, the risk of rising commodity prices will diminish, as demand for commodities might decline. However, the willingness of companies to compensate for the impact of the crisis may be stronger than in other phases of the recovery. At the same time, it is questionable whether this will be a particularly strong driver of inflation.
  • Fiscal stimuli amount to about USD 12.5 trillion globally, about five times as much as during the 2008 -2009 financial crisis. This time around, households and businesses have been hit the hardest. The impact on demand is expected to be visible as soon as the Covid-19 restrictions are eased, which would boost demand. Moreover, household finances did not suffer as much this time.
  • Global wage growth has been relatively slow despite the labour market circumstances, reflecting the impact of globalisation over the past 15-20 years. The influx of workers from Asia has limited the rise in costs. Digital technologies and automation – what and how we buy and consume – will continue to permanently change the labour market. This will lead to a redistribution of sectors, and therefore a change in demand for different occupations, which will reduce wage growth and inflationary pressures, at least in the short term.
  • Covid-19 will contribute to regionalisation to protect global supply chains from new shocks such as new pandemics, protectionism, or trade barriers. Protectionism has increased the concerns about higher global inflationary pressures. However, even well-functioning supply chains and new trade agreements do not signal of the death of globalisation.
  • Inflation will be affected by rising oil prices, particularly in the first half of this year. However, the higher the rise, the faster US beneficiaries will come into play. At the same time, oil prices are expected to rise to USD 100 if the recovery is successful. However, rising commodity prices often only have a short-term impact on inflation.

Stable inflation for over 700 years

Over the past 20 years, inflation in OECD countries has remained remarkably stable at around 1.5%, despite several severe crises. According to the Bank of England analysis, global inflation has averaged 1.6% over the past 700 years. Challenging these long-term inflation trends is difficult, although there are, of course, enough flaws in the inflation data over the last 700 years.

If you exclude short-term effects, inflation is hardly that invisible. But it is still below the level desired by central banks. It should be noted that the risk of deflation is low despite the serious circumstances in many economies.

Increased confidence in the US economy has led to rising inflation expectations. The chairman of the FED Jerome Powell has had a special focus on the labour market, noting that full employment is still very far away and has called for continued expansionary monetary policy as well as broader efforts to address labour market losses.

The Head of FED is still more concerned about deflationary forces than rising inflation. The question remains, what needs to be done before the FED can start reducing asset purchases? The labour market has lost 15 million Americans since the financial crisis, which means that the structural problems are much deeper, whereas the solutions are more intricate than those proposed by many populists.

Dainis Gašpuitis
Economist at SEB

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