Ever since the 2008 financial crisis, pessimists have been saying we are due a global inflation surge. So far they’ve been wrong. The world’s economies, particularly the rich ones, have sucked up fiscal and monetary stimulus and the biggest official concern has usually been that the inflation rate is too low.
But even a stopped clock eventually shows the right time. Given Covid-induced monetary and fiscal overdrive, might the worriers finally be proved right?
Former University of Chicago economist John Cochrane says that by conventional measures of monetary policy higher inflation is well overdue. There is the small problem that conventional measures have been wrong for the last decade or so. Cochrane thinks this is because inflation expectations have been surprisingly stable.
And he fears that this is changing. He draws attention to new confidence at the US central bank that monetary policy can:
“… seek to eliminate shortfalls of employment from its maximum level [emphasis added], in contrast to the previous approach that called for policy to minimize deviations when employment is too high as well as too low”.
He feels this confidence – which he candidly acknowledges is widely shared – smacks of 1960s hubris. He naturally asks himself if current policymakers are as willing as their 1980s-era counterparts to take responsibility for an “agonizing recession to bring down inflation, followed by 15 years of historically unprecedented high interest rates”. Because he sees a link between that willingness and the stability of inflationary expectations in the current environment.
It’s a similar perspective to that of Niall Ferguson writing at Bloomberg, one of those rare historians with great fluency in economics and finance.
Given his own previously-misplaced pessimism, Ferguson is at pains to acknowledge possible reasons why this time is different and inflation may remain firmly under control (eg, the economy is more flexible; people want to hold more cash; we are recovering from the Covid supply shock).
But looking through a historical prism, Ferguson sees that:
“… monetary expansions, like the fiscal deficits with which they are often associated, are the result of policy decisions, which are rooted in decision-makers’ mental models, which originate in some combination of experience and the study of history”.
And he warns:
“The Fed folks are telling us that inflation expectations will stay anchored, even if inflation jumps above 2% for a time. The big beasts of economics and investment may just have longer memories”
Ferguson sees echoes of the 1960s in current social discontent. And once this stuff starts driving policy, it can quickly overwhelm the arguments of the technocrats, not least when their mental models are failing to perform.
Of course an uptick in global inflation would not necessarily transmit into a New Zealand economy running an independent monetary policy. Lower public debt levels and an ok private sector productivity record would provide some support.
But external inflation could add to the pressures on a government struggling with questions of fiscal discipline, private debt build-up and a dislike of market flexibility and its outcomes.
Ferguson may have been thinking more widely than monetary economists when he suggests that:
“… thirty years of very low inflation seems like the perfect basis for a wrong model”.