The debate about whether high inflation will emerge out of the pandemic is becoming more pressing. In January underlying prices in the euro zone rose at their fastest pace for five years. In America some economists fear that President Joe Biden’s planned $1.9trn stimulus, which includes $1,400 cheques for most Americans, may overheat the economy once vaccines allow service industries to reopen fully. Emerging bottlenecks threaten to raise the price of goods. Space on container ships costs 180% more than a year ago and a shortage of semiconductors caused by this year’s boom in demand for tech equipment is disrupting the production of cars, computers and smartphones.
Headline statistics on price rises will soon contribute to the sense that an inflationary dawn is breaking. They will go up automatically as the collapse in commodities prices early in the pandemic falls out of comparisons with a year earlier, and the recent rise in the oil price begins to bite—on February 8th Brent crude rose above $60 a barrel for the first time in more than a year. In Germany the reversal of a temporary cut in vat has already helped year-on-year inflation rise from -0.7% to 1.6% in a month.
For most of the past decade the world economy’s problem, judged by central banks’ targets, has been too little inflation, not too much. As a result it is easy to view the coming acceleration in prices as welcome. In fact, it is worth worrying about, for several reasons.
One is that it weakens the hand of those arguing for more fiscal stimulus in places that need it. There is little prospect of the euro zone sustaining higher inflation, for example. Its main rate of interest has not been cut during the pandemic and its deficit spending remains inadequate given its economic outlook and lack of monetary firepower. Much as the European Central Bank mistakenly raised rates in response to a temporary burst of inflation in 2011, the danger this time is that a temporary acceleration in prices emboldens fiscal hawks who are complacent about the dangers of a depressed economy. The same danger lurks in Japan, the archetypal low-inflation economy. Its prices started falling during the pandemic. Japan will probably escape deflation this year, but beyond that it looks destined to remain in a low-inflation trap, having seemingly given up on its brief attempt to spring out of it in the mid-2010s.
Higher inflation could also cause gyrations in monetary policy in America, where rising inflation expectations and a faster rebound mean price rises are more likely to prove persistent. Financial markets imply a one-in-five chance that consumer prices will grow by at least 3% per year on average over the next five years. The Federal Reserve has promised to keep interest rates low and to keep buying bonds because it wants inflation to overshoot its 2% target, in order to make up for today’s shortfalls. But its new “average inflation targeting” regime does not allow for an enduring or large overshoot. Eventually the central bank will want to raise interest rates to bring inflation back down.
The faster prices rise this year, the sooner that tightening could come. Richard Clarida, the Fed’s vice-chairman, has said that the central bank will make up only for inflation shortfalls that have occurred over the preceding year, meaning the point at which catch-up is complete could come surprisingly quickly. On February 7th Janet Yellen, the Treasury secretary, tried to reassure critics of Mr Biden’s stimulus by saying that America has the tools to deal with inflation. But higher rates are not without consequence, and if the Fed finds itself pouring cold water on an overheating economy, the risks of another recession will rise.
Higher rates also hold deep implications for markets. Almost everything about today’s financial landscape is premised on central banks keeping interest rates low for a long time. Cheap money lies behind the idea that the government can spend however much it likes—including, say, on Mr Biden’s planned infrastructure bill—and underpins today’s sky-high stockmarket values and abundant credit. An abrupt change in the interest-rate outlook would be painful, as it was in 2013 when the Fed’s hawkish comments led to what became known as the “taper tantrum”.
On Wall Street higher rates would be a shock. In emerging markets they would be agonising. Many have been experimenting with unconventional monetary policy and bigger budget deficits, following the rich world (see article). But their efforts assume that global financial conditions will stay loose. Higher interest rates in America to see off inflation would mean a stronger dollar and capital outflows from emerging economies, as in 2013. This would imperil their finances and make it harder for them to fight the effects of the pandemic. There is a lot to like about the idea of escaping the low-inflation, low-rate paradigm of the past decade. But higher inflation will expose the world economy and financial markets to a bumpy ride.
This article appeared in the Leaders section of the print edition under the headline “Inflategate” of The Economist.
Reference: How rising inflation could disrupt the world’s economic policies. (2021). Retrieved 23 February 2021, from https://www.economist.com/leaders/2021/02/10/how-rising-inflation-could-disrupt-the-worlds-economic-policies