Is high inflation making a comeback?
Prices are rising quickly across much of the developed world with inflation in OECD countries increasing at the highest rate since 2008. In the US, core consumer inflation has surged at a pace not seen since 1992. Central Banks have so far maintained the inflationary pressures are temporary and will abate on their own, although US Fed officials acknowledged on Wednesday that price rises may last longer than they expected.
There are growing concerns that Central Banks and policymakers have misjudged the resilience of the inflationary pressures and we may be in for a period of sustained inflation not seen in the developed world for many decades. The risks are high if their consensus view is wrong. Deutsche Bank chief economist David Folkerts-Landau said in a recent report the global economy is heading for a “devastating rise in inflation:
“We worry that the painful lessons of an inflationary past are being ignored by central bankers, either because they really believe that this time is different, or they have bought into a new paradigm that low-interest rates are here to stay, or they are protecting their institutions by not trying to hold back a political steam-roller,”
Mohamed El-Erian president of Queens College, Cambridge agrees, believing the Fed is moving too slowly in terms of keeping inflation in check. He argues if Central Banks wait, they will have to “slam on the breaks” by raising interest rates quickly. This creates a real risk of sending the economy into a recession.
The reasons for the surge
A lot of the reasons for the surge in inflation can be attributed to transitory factors which support the official line. A year ago, much of the world was in lockdown, and demand for many goods and services plummeted. However, there is now a lot of pent-up demand and as many countries begin opening their economies, demand is surging.
The demand pressures have been exacerbated by disruptions to global supply chains. Shipping containers in the wrong geographic location and the lack of availability of container ships have made it difficult for producers to access raw materials leading to a rise in commodity prices like lumber, copper, wheat and iron ore.
On top of this, border closures have led shortage of workers, which has been driving up wages in some industries and increasing the likelihood that prices will continue to rise.
The difficulty of measuring inflation through measures like the CPI and durable goods is that it can be affected by “noise” such as transient supply shocks (i.e. acts of nature)
The Underlying Inflation Gauge (UIG) was developed by the Federal Reserve Bank of New York as a way to counter this and to capture the “persistent part” of monthly inflation.
The UIG has outperformed measures of core inflation and predicted the downturn in 2008, peaking from 2004–2006. It has recently spiked 3.2% and is “flashing yellow” according to Eddy Vataru of Osterweis Capital Management. Vataru argues that money printing plus the addition of significant fiscal stimulus will lead to persistent inflation.
UIG: Full data set measure
The case against a long-term rise in inflation
Those who believe the inflationary surge in the US is transitory argue that a “v-shaped” recovery was always on the cards as economies re-opened and experienced a bump in demand. The largest price rises have been seen in areas which were hit the hardest by the pandemic such as petrol (up 56.2%) and used cars (up 29.7%) or tied to the economic reopening, such as airline and hotel prices. This may mean that the growth in demand and prices will start to normalise once countries have fully opened up and supply issues are resolved.
Today’s economy is also very different from the 1970s when rapidly rising inflation created havoc:
- Unionisation levels were higher and workers in the 1970s were in a much stronger position to demand higher wages.
- Demographic trends in the 1970s and 1980s also saw a huge rise in working-age people, providing a tailwind for demand.
- Globalisation today is a much bigger factor despite the recent slowdown so there is significantly more international competition holding prices down.
- The massive technological advances since the 1970s are also inherently deflationary, tending to reduce costs while increasing competition.
All these factors support the view that the current inflationary pressures are transitory and are likely to dissipate over time.
New Zealand quiet for now
The RBNZ is forecasting inflation to move to the upper half of its 1–3% band this year and then to slow in 2022. New Zealand won’t be immune to international inflationary pressures if they blow through though, and interest rates are expected to rise, which could ultimately cause problems for households with ever-increasing levels of debt.
We won’t know for a few more months whether inflation is short-lived or more permanent. However, there is a growing chorus of voices encouraging early action on inflationary pressures. This includes outgoing Bank of England Chief Economist Andy Haldane who recently warned in the New Statesman that the stakes were high, not just for central banks and governments, but also financial markets, businesses, and consumers. “The inflation tiger is never dead,” he wrote. “While nothing is assured, acting early as inflation risks grow is the best way of heading off future threat. This is monetary policy 101”