Just because pandemic inflation is transitory doesn’t mean it’s going away anytime soon.
That’s the awkward conclusion that policy makers and investors are arriving at, as prices accelerate all over the world. European natural gas has climbed 25% in two weeks, and oil topped $80 for the first time since 2014. Fertilizers hit a record on Friday, which means food prices -- already at a 10-year peak -- will likely rise even higher.
Central banks suddenly sound a bit more concerned about inflation -- though it’s not clear how tighter monetary policy can fix broken supply-chains, or alleviate an energy squeeze -- and money managers want higher yields when they buy bonds. With economic recoveries slowing too, there’s even talk of “stagflation.”
Much of what’s driving prices, from shipping delays to post-lockdown surges in demand, looks like a one-time consequence of Covid-19, which is why the consensus has been that any spike in inflation won’t last long.
But that view is shifting. Last week, Huw Pill, the Bank of England’s new chief economist, said the “magnitude and duration of the transient inflation spike is proving greater than expected.”
Covid is far from contained, which means there’ll likely be more factory closures and bottlenecks. Even when the pandemic does end, there may be legacies -- households with surplus savings, or shortages of certain kinds of worker –- that tend to keep inflation higher. And the energy-price surge will push up the costs of many other products.
None of this necessarily means that the long era of low inflation is gone for good.
The cost of living isn’t soaring everywhere. Inflation is negative in Japan and subdued elsewhere in Asia. And there are deep-rooted forces, from trade to the erosion of labor power, that kept a lid on prices before the pandemic and could reassert themselves once it’s over.
IMF Calls the Peak
“Our forecast is that annual inflation in advanced economies will peak at 3.6% on average in the final months of this year before reverting in the first half of 2022 to 2%, in line with central bank targets. Emerging markets will see faster increases, reaching 6.8% on average then easing to 4%.”
--Click here for more from International Monetary Fund.
Following is a roundup of the main reasons why economists are starting to think pandemic inflation will be higher for longer -– and why most of them still expect it to eventually subside.
Inflation Is Sticky Because: Supply Chains Are Still Tangled…
In the pandemic, consumers found many of the services they typically spent money on, from air travel to gym membership, were unavailable or unappealing. They bought more goods instead –- putting massive pressure on the world’s capacity to make stuff and move it around.
Those strains aren’t easing up just yet. Demand is still skewed toward goods, but localized virus outbreaks, shortages of raw materials and other inputs, and spotty energy supplies continue to crimp supply.
IHS Markit just slashed its forecast for global auto production in 2022 by more than 9%, citing the lack of semiconductors. Vietnamese factories that make shoes and clothes for the world are threatened by a mass exodus of migrant workers, who prefer to wait out the pandemic in their home provinces.
What’s more, pandemic shortages led many governments and firms to rethink their dependence on foreign suppliers and lean inventories. Sourcing locally and keeping more goods on hand could increase costs. The European Union, for example, wants to make more semiconductors domestically. That would require policies like subsidies or import taxes, which would likely be inflationary.
…Households Are Flush…
Mostly because they were stuck at home, and partly because they were getting more government benefits, citizens of rich countries stashed away record amounts over the past 18 months. Americans amassed excess savings of about $2.5 trillion as of June, according to Federal Reserve data. In the euro area, households had accumulated 540 billion euros by the start of the year.
That firepower could help to sustain consumer spending even as prices rise.
Economists reckon that people don’t usually spend much of their savings on consumption. But money accumulated involuntarily in the pandemic may be different, a report for the European Parliament argued. If at least some households decide to treat it as extra income rather than savings, “the impact on private consumption would be large.”
…And Labor Has Woken
Wages have grown slowly in recent decades, helping keep prices subdued, but many analysts think that could be about to change.
Unemployment remains higher than it was before the pandemic, which wouldn’t usually be conducive to pay raises: It’s easy for bosses to say ‘no’ when there’s a large pool of potential replacements. But job openings are also at record highs, in the U.S. and elsewhere, and that’s given workers in some industries more bargaining power. They may press for higher wages if inflation keeps eating away at their purchasing power.
Demographics could drive a longer-term shift in favor of labor in developed nations -– with shrinking working-age populations bringing higher pay, and perhaps more inflation. And globalization may not weigh down prices the way it has since late last century, when goods from China, Eastern Europe and other developing nations began flooding store shelves. That cycle is ending because there’s no new pool of low-cost workers left out there for companies to tap.
It’s Transitory Because: The Pandemic Is a One-Off…
One day the coronavirus will be conquered -- or at least contained -- and people will go back to their old habits. And when they do, many of the forces that have driven inflation up this past year will go into reverse and help to pull it back down. This is the core of the argument made by the “transitory” camp.
“Consumers will substitute ‘stuff’ for ‘experiences’, easing the pressures on global industry,” is how economist Dario Perkins at TS Lombard puts it. “The flexibility of goods prices –- a source of inflation in 2021 -– should become a source of disinflation. Historically, this has always been the case.”
Even if Covid-19 lingers, there’ll probably be no repeat of the most dramatic episodes that helped drive inflation -- like large transfer payments from governments to households, or near-worldwide lockdowns that led to explosions of pent-up demand when they ended.
…Stimulus Is Finishing…
Government spending is what pulled economies through. But by next year, fiscal policy will be a drag on economic growth rather than a contributor to it -- which should cool inflationary pressures.
In the last couple of decades, the political bias in the developed world has been toward austerity, and that likely hasn’t disappeared completely. In the U.S., President Joe Biden’s Democrats are scaling back their spending plans. Europe may tweak its budget caps before reinstating them, but there’s probably not enough political momentum to scrap them altogether.
Meanwhile, central banks -- which have limited capacity to speed up economies nowadays -- still have powerful brakes. They haven’t forgotten how to use them, even if they’re now inclined to tolerate slightly higher inflation. That credibility is one reason why investors have been willing to look beyond this year’s spike in prices.
Some are already acting, with New Zealand and Norway among those hiking interest rates. The Fed is preparing to slow its asset-purchase program.
What Central Banks Say...
“The red zone for everyone is if inflation became persistent at a number that’s immoderately above the inflation target. That’s a very far distance from where the euro area is. We have to be the counterweight, honestly, in this debate.”
-- ECB Chief Economist Philip Lane. Read more here.
Supply disruptions and price pressures are “proving more complicated, they are continuing, so there is some risk that there’s a bit more persistence than we previously thought. There are good reasons to believe that they are temporary.”
-- Bank of Canada Governor Tiff Macklem. Read more here
…And the Big Picture Hasn’t Changed
Fed Chair Jerome Powell told Congress early this year that inflation dynamics don’t “change on a dime.” He was referring to long-run forces that kept inflation low –- and haven’t gone away.
Labor doesn’t have the power to bid wages up like it did during the inflationary 1970s. Globalized trade, which has brought cheaper goods, has rebounded from the pandemic. Technological breakthroughs are accelerating, and many of them are cost-savers.
For more than a decade before the pandemic, a deflationary trap looked like a bigger risk for developed economies than runaway prices. When the dust settles after the pandemic, that may still be true.
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