A famous economist once said, roughly, that inflation is anywhere and everywhere a monetary phenomenon. One might not disagree, but one could add that inflation is, in a sense, pretty much always and everywhere, a “political” phenomenon, or one can be even more reductionist and note that it is a “human” one. And there’s the rub, decision-making – at the policy level and among individuals – that decision-making will shape inflation trajectories and affect prospects for investors and lenders in the global markets. The key will be to observe these decisions in the context of underlying structures and capacities.
One might also justifiably say that US annual inflation posting at an 8.3% clip as of this past April has placed a capstone on the monumental ending of what had been “The Great Moderation”, or the slowing of inflation and the ratcheting down of interest rates since the Volker Fed, all the way through – wait for it, another “great” event, “The Great Financial Crisis (GFC)”, that embroiled the world from 2007 to 2010, roughly.
To make an additional point, the Economist Intelligence Unit (EIU) estimates that the US inflation pace will ease but not really by that much, at least near term, with an annual inflation rate of 7.7% for 2022.
So, what gives? And, what happened?
Before delving in, we would like to cite another forecast – the composite US inflation forecast cited in Trading Economics, the financial website and database. They also point to the April level at 8.3%, but expect more of a slowing clip, one posting at 7.0% for QII, 5.8% during QIII, then 4.3% for QIV. Trading Economics puts annual inflation at 2.9% for QI 2023, and at an overall annual clip of 1.9% for 2023.
Again, so what gives?
Agustin Carstens, the General Manager at the Bank for International Settlements (BIS), attempts to answer this. He makes an effort to do so in his “The Return of Inflation” speech, given on April 5th at the International Center for Monetary and Banking Studies in Geneva.
Mr. Carstens underscores some “structural” aspects to resurgent inflation, He notes among other factors that globalization, which he contends contributed to the erstwhile long-term trend of moderating inflation, may now be in retreat. A new manufacturing trend, one that departs from a reliance on cost effective but vulnerable supply chains, may be developing. The dislocating effects from the Covid pandemic and worsening geopolitical tensions might mean that global businesses and national economies might be more inclined to forego marginal efficiency gains for better security, incurring a risk premium that consumers ultimately pay.
On a global basis, we are already paying. According to the BIS, the share of the world’s advanced economies (AEs) with annual inflation exceeding five percent exceeded 60%, the “largest share since the 1980s”. Among the emerging market economies, more than 50% have annual inflation rates exceeding seven percent. There is now a better likelihood that greater inflation expectations are being sown throughout the global economy.
In his speech, the BIS economist highlights how the sharp fiscal and monetary policy response – in reaction to the stoppages of the pandemic – more than primed the pump. Stoked global demand – when progressively unleashed from Covid strictures – promptly became acute, and there arose, according to Mr. Carstens, a “persistent rotation” toward the demand for goods, rather than services, exciting consumer inflation in many economies because of developing “bottlenecks” in the global economy. Because of the enduring effects of the Covid crisis, aggregate supply stood in some instances “unresponsive” to the surge in demand, due to those bottlenecks, for example, in shipping and the availability of semi-conductor chips.
And, energy costs proved to be a prime inflationary irritant as well. As of May 17th, the price of a barrel of Brent crude closed at USD 112.20, nearly 66% higher than levels posted one year ago. People, namely the current US administration, attribute this solely to what they call “the Putin price hike”, and the geopolitical dislocation in the global energy markets.
But perhaps, domestic policy measures curtailing the bandwidth of the US energy sector could have had something to do it with it, too. The creation of fiat purchasing power through transfers were vital for US households – shut-down and shut-in in the midst of the pandemic – but maybe those transfers became, as political largesse often does, too expansive and protracted, especially as US society and the economy began emerging from Covid, and supply chain constraints began asserting themselves.
What Mr. Carstens fears are an onset of entrenched inflationary expectations and a new perilous kind of “me too” development, where inflation more easily spills over from one economic sector to another. Inflationary momentum is a bad thing, Mr. Carstens warns us, and assumes a very negative dynamic, “When inflation starts affecting the ‘cost of living’ in a broad sense, it is more likely to take center stage in price- and wage-setting decisions…” Mr. Carstens, for one, fears the risk of a wage-price spiral, if inflation proves to be obdurate.
So, war, geopolitical adventurism, policy excesses perhaps, plague and official confoundedness have all contributed to the interruption of the Great Moderation. What is the global risk taker to do?
The answer is a truism, but that makes it no less valid. The step to take (i.e. the answer to have) will be to listen to what people say, but also watch what they do. Differences in forecasts on inflation – some seeing stubborn, persistent high inflation, others seeing inflation that moderates significantly into 2023 – maybe reflect acknowledgement, by some, of the disinflationary forces present in an open economy, if those forces were only to left to manifest themselves: Competitive markets entail and incentivize participants “to offer a better product at better prices”, since winners in that competition gain market share. Moreover, open and competitive economies allow for spoilers and challengers to incumbents, ideally preventing monopolistic conditions and price setting to arise. Also, in free and open societies and economies, innovations in information and technology facilitate business efforts to address demand more effectively, and more cheaply – since the incentives are there to do that.
Global risk takers must listen to what the pointy-headed types, business leaders and politicians say, but they must watch what states and policy-makers do. The convalescing planetary covid patient had been recovering and moving about. May those in charge heed that important kernel in the Hippocratic oath, to “do no harm.” And, let that patient stand up and brush himself off.