He is now worried. “Financial markets are going to have to get used to the return of troublesome problems which, until recently, seemed long dead,” he wrote in May.
Central bankers have not had to deal with an inflation problem in their careers. After averaging around 10% per year in the 1970s and 1980s, global inflation rates fell to an average of close to 5% in the 1990s in rich OECD countries, to 3% in the 2000s and at 2%. in the 2010s.
The question today is whether their point of view is complacent. Is the world entering another inflationary era?
While many households believe the definition of price stability would be an absence of inflation, economists and policymakers favor a small annual price increase of around 2%.
This reduces the risk that an economic crisis will trigger a deflationary spiral with falling spending, prices and wages, increasing the real burden of debt and further affecting spending.
Holger Schmieding, chief economist at Berenberg Bank, explains that a little inflation also greases the wheels of the economy, allowing declining sectors to lag gracefully.
In most advanced economies – the United States, the euro area, and Japan – central banks fell short of their inflation targets of around 2%, although they cut interest rates to zero and created trillions of dollars, euros and yen, which were pumped into their savings by buying public debt.
A modest rise in inflation would therefore be welcomed by central banks, which have generally been delegated the task of ensuring price stability.
And until this year, the main economic concern with prices was the risk that countries would become Japanese and could soon emulate that country’s 30-year struggle with mild deflation.
Such was the difficulty of keeping inflation high enough that some economists even began to question the doctrine of Ben Bernanke, the former Fed chairman who argued in 2002 that “in a paper money system, a determined government can always generate higher expenditure and therefore positive inflation. ”.
But that worldview shifted in 2021. A new Biden administration’s new program of borrowing and spending at any cost, forced savings during the coronavirus crisis, giving households extra firepower, bottlenecks in the economy. The bottleneck in the supply of goods and a reversal of long-standing downward pressures on wages and world prices have rekindled fears of excessive inflation.
No one is talking about hyperinflation of the type seen in Weimar, Germany in 1923 or Latin America in the 1980s, or even the world rate of 10% in the 1970s, but a creeping increase to persistent levels of Widespread price increases not seen in a generation. .
When the US inflation rate jumped to 4.2 percent in April, financial markets collapsed.
The new concern about a return of inflation is not only the result of immediate economic forces, but also reflects longer-term underlying changes in the structure of the world economy.
The aggressive economic stimulus is being adopted just as the global economy is feeling the impact of an aging population and the maturing of China’s 40-year transition.
Moreover, history also tells us that neither politicians, economists nor policy makers can guarantee that the world will keep inflation low and stable.
As the Fed’s experience in the 1960s shows, turning points in inflation come with little warning.
Unlike the United States, where there was no fear of inflation after World War II, concerns about inflation were still “booming” following devaluations of the pound sterling and rising prices of US dollars. imports into the UK during the full employment years of the 1950s and 1960s, according to Nick Crafts, professor of economic history at the University of Sussex.
But it only really took off in the 1970s after OPEC’s first oil shock and the government’s shift from austerity to “massively excessive stimulus, pushing the economy beyond reasonable estimate.” the sustainable level of unemployment, ”says Crafts.
According to Karen Ward, chief European markets strategist at JPMorgan Asset Management, the Bernanke doctrine still stands and should not be forgotten.
“We have always assumed that structural improvements on the supply side such as technology and globalization are so important that we could never overwhelm them with demand, but it must always be true that you can overwhelm the supply with demand and ultimately generate inflation. ”she says.
It is precisely this fear that is currently pushing up inflation expectations in the United States and Europe.
Along with a recovery in energy prices to pre-COVID-19 levels, there has been a shortage of microchips, wood products, many metals, and even cheese.
These were the immediate causes of higher inflation, but financial markets fear that the ultimate cause may have been the pandemic-related fiscal and monetary stimulus which has led to a much faster economic recovery in economies. advances than previously thought possible at the end of 2020.
As economic policy puts more pressure on the accelerator than at any time in recent history, spending could exceed the ability of economies to deliver goods and services, especially if the coronavirus crisis and government support made people less willing to work, creating labor shortages and pressure on companies to raise wages.
Such is the potential imbalance between soaring demand and more limited supply, especially in the United States, some supporters of center-left politics say the warning lights are flashing.
Larry Summers, Secretary of the Treasury in the Clinton administration, believes the policy has become far too lax, repeatedly criticizing the “dangerous complacency” in the face of inflation among policymakers today.
While the White House fought back, claiming that “a strong economy depends on a solid foundation of public investment, and that investments in workers, families and communities can pay off for decades to come,” even Janet Yellen, the current Secretary of the Treasury, has recognized the possible need for higher interest rates “to ensure that our economy does not overheat.”
The policy shift came at a time when economists generally accept that some of the big global forces that keep prices low are much weaker than they were.
In the 1990s and 2000s, globalization resulted in a huge shift in the production of goods from high-wage economies to China and Eastern Europe, accelerating the decline of the power of workers in advanced economies to force their employers. to pay them more, while keeping prices low.
But those forces are at a crossroads, according to Charles Goodhart, former chief economist at the Bank of England and author of the book The great demographic shift. Its long boom in the size of its workforce is over, and its population is on the verge of falling for the first time in decades.
Goodhart says fewer new workers entering the global workforce at a time of shrinking workforces in advanced economies as the population ages will increase pressures on companies to raise wages , increasing underlying inflationary pressures.
Changing demographic pressures have already been around for a decade and are intensifying, he says. He had been reluctant to date inflation to come, saying the world would likely experience increased inflationary pressures within five years and “we’re pretty sure that would have happened by 2030”.
This was before COVID-19 hit. Now, he says, the underlying pressures, along with more stimulating policies and supply restrictions related to COVID-19, have advanced the moment.
“We tend to think that due to supply constraints in particular, it is going to be more inflationary in 2021 than central bankers originally thought and it will last longer in 2022 and 2023 because there will be a confluence of the accumulation of large monetary balances … combined with continued large fiscal expansion.
Turning to specific examples of prices he expects to see rise, Goodhart notes how additional demand for UK vacations would drive up the prices of vacation rentals, hotels and even ice cream this Nordic summer. “You would have to be a saint not to increase your prices,” he says.
Population pressures are not something that can be reversed quickly, nor are the forces of globalization, which he says have receded after becoming politically unpopular in many advanced economies.
Again, this is more acute in the United States where economists such as Adam Posen, president of the Peterson Institute for International Economics, urge Americans to “embrace economic change rather than nostalgia” in domestic production, particularly in manufacturing, as a way to improve life. standards and promote non-inflationary growth.
So far, however, although financial market inflation expectations have risen sharply in 2021, key policy makers remain calm.
There is growing discussion within the Fed that members of the interest rate setting committee must, at some point, think about reducing the pace of money creation and bond buying. of state. But the opinion is that inflation is returning to more normal levels and the US central bank is committed to maintaining an ultra-accommodative policy until it achieves a more inclusive recovery.
This is the right approach, says Laurence Boone, chief economist of the OECD in Paris, a view that joins similar attitudes in central banks around the world.
“It’s too early to sound the alarm bells about inflation,” she said.
“This does not mean that we should not look at what is happening, and we are seeing friction with the reopening of demand and supply after the crisis … but good policy is to ease tensions on the side. supply more than central banking action [to quell inflationary pressures]. “
In most economies, the labor market remains slack, adds Boone, and strong demographic pressures could be significantly alleviated with later retirement, while other parts of Asia and Africa would be happy to integrate. in the global economy, as has China.
Boone’s point of view still represents the consensus view among economists and central banks are very confident that any rise in inflation this year will be temporary and easily contained without having to tighten policy considerably.
But, for the first time in many decades, it’s possible that an important turning point has come, that the price hikes are more than a flash in the pan and something more difficult to control.