Economics Essay 30: Quantitative Easing

 Discuss whether a reversal of QE is likely to be economically beneficial.

Quantitative Easing (QE) is an unconventional monetary policy tool used by central banks to stimulate the economy when traditional monetary policy measures, such as lowering interest rates, are insufficient. It involves the central bank purchasing government bonds or other financial assets from commercial banks and injecting liquidity into the economy. The goal of QE is to lower borrowing costs, increase lending, and encourage spending to stimulate economic growth.

When evaluating the potential economic benefits of reversing QE, several factors need to be considered:

1. Economic Growth: Reversing QE has the potential to impact economic growth. As liquidity is withdrawn from the economy, it may lead to tighter financial conditions, higher borrowing costs, and reduced consumer and business spending. This could result in a slowdown in economic growth or even a contraction in some cases.

2. Unemployment: The impact of reversing QE on unemployment is complex and depends on the specific circumstances. Tightening liquidity may lead to reduced business investment and hiring, potentially leading to job losses. However, if reversing QE is undertaken to control inflationary pressures, it can help maintain price stability, which in turn can support long-term economic growth and employment stability.

3. Inflation: Reversing QE can be used as a tool to control inflationary pressures in the economy. If the central bank perceives that inflation is becoming a concern due to excessive money supply, reversing QE can help tighten monetary policy and prevent inflation from spiraling out of control. This can contribute to price stability and maintain the purchasing power of consumers.

4. Balance of Payments: Reversing QE may have implications for a country's balance of payments. As liquidity is withdrawn from the economy, it could result in a stronger domestic currency, which may impact export competitiveness. A stronger currency can make exports relatively more expensive and imports cheaper, potentially leading to a deterioration in the trade balance and a higher current account deficit.

5. Financial Markets: The reversal of QE can have significant impacts on financial markets. Selling off large amounts of assets acquired through QE may lead to market disruptions and increased volatility. Investors and market participants may need to adjust their investment strategies and asset allocations in response to the changing liquidity conditions, which could impact asset prices and overall market stability.

6. Confidence and Expectations: Reversing QE requires clear and effective communication from the central bank to manage market expectations. Changes in monetary policy can influence investor and consumer confidence. If the central bank successfully conveys a sense of stability and a well-managed transition, it can help maintain confidence in the economy and minimize disruptions.

It's important to note that the effects of reversing QE can vary depending on the specific economic conditions, the timing and pace of the reversal, and the effectiveness of the central bank's communication and policy implementation. Careful assessment and consideration of the potential impacts on growth, unemployment, inflation, balance of payments, and financial markets are necessary to ensure that the benefits outweigh any potential drawbacks.

While the reversal of QE may help address inflationary pressures and promote long-term economic stability, it also carries potential risks. The withdrawal of liquidity can tighten financial conditions, leading to slower economic growth and potential job losses. Additionally, the impact on financial markets and investor confidence should be closely monitored to mitigate any disruptions.

Furthermore, free market fundamentalists argue that the market should be left to correct itself without excessive government intervention, including unconventional monetary policies like QE. They believe that market forces should determine interest rates, asset prices, and economic growth without central bank intervention.

In conclusion, the reversal of QE should be carefully evaluated, taking into account its potential impacts on economic growth, unemployment, inflation, balance of payments, and financial markets. The timing, pace, and communication of the reversal are crucial to managing market expectations and minimizing disruptions. While QE can provide short-term stimulus, its long-term effects and potential risks should be carefully considered in the context of specific economic conditions.

Raising interest rates to tame inflation will only cause more pain

Central banks are set on a path to cause recession – and marginalised people will pay the price writes Joseph Stiglitz in The Guardian

Higher interest rates will not do what people need, such as lower the price of food. 



Central banks’ unwavering determination to increase interest rates is truly remarkable. In the name of taming inflation, they have deliberately set themselves on a path to cause a recession – or to worsen it if it comes anyway. Moreover, they openly acknowledge the pain their policies will cause, even if they don’t emphasise that it is the poor and marginalised, not their friends on Wall Street, who will bear the brunt of it. And in the US, this pain will disproportionately befall people of colour.

As a new Roosevelt Institute report that I co-authored shows, any benefits from the extra interest rate-driven reduction in inflation will be minimal, compared with what would have happened anyway. Inflation already appears to be easing. It may be moderating more slowly than optimists hoped a year ago – before Russia’s war in Ukraine – but it is moderating nonetheless, and for the same reasons that optimists had outlined. For example, high auto prices, caused by a shortage of computer chips, would come down as the bottlenecks were resolved. That has been happening, and car inventories have indeed been rising.

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Optimists also expected oil prices to decrease, rather than continuing to increase; that, too, is precisely what has happened. In fact, the declining cost of renewables implies that the long-run price of oil will fall even lower than today’s price. It is a shame that we didn’t move to renewables earlier. We would have been much better insulated from the vagaries of fossil fuel prices, and far less vulnerable to the whims of petrostate dictators such as the Russian president, Vladimir Putin, and Saudi Arabia’s own leader, Crown Prince Mohammed bin Salman (widely known as MBS). We should be thankful that both men failed in their apparent attempt to influence the US 2022 midterm election by sharply cutting oil production in early October.  

Yet another reason for optimism has to do with markups – the amount by which prices exceed costs. While markups have risen slowly with the increased monopolisation of the US economy, they have soared since the onset of the Covid-19 crisis. As the economy emerges more fully from the pandemic (and, one hopes, from the war) they should decrease, thereby moderating inflation. Yes, wages have been temporarily rising faster than in the pre-pandemic period but that is a good thing. There has been a huge secular increase in inequality, which the recent decrease in workers’ real (inflation-adjusted) wages has only made worse.

The Roosevelt report also dispenses with the argument that today’s inflation is down to excessive pandemic spending, and that bringing it back down requires a long period of high unemployment. Demand-driven inflation occurs when aggregate demand exceeds potential aggregate supply. But that, for the most part, has not been happening. Instead, the pandemic gave rise to numerous sectoral supply constraints and demand shifts that – with adjustment asymmetries – became the primary drivers of price growth.

Consider, for example, that there are fewer Americans today than there were expected to be before the pandemic. Not only did Trump-era Covid-19 policies contribute to the loss of more than a million people in the US (and that is just the official figure) but immigration also declined, owing to new restrictions and a generally less welcoming, more xenophobic environment. The driver of the increase in rents was thus not a large increase in the need for housing but rather the widespread shift to remote work, which changed where people (particularly knowledge workers) wanted to live. As many professionals moved, rents and housing costs increased in some areas and fell in others. But rents where demand increased rose more than those where demand fell decreased; thus, the demand shift contributed to overall inflation. 

Let us return to the big policy question at hand. Will higher interest rates increase the supply of chips for cars, or the supply of oil (somehow persuading MBS to supply more)? Will they lower the price of food, other than by reducing global incomes so much that people pare their diets? Of course not. On the contrary, higher interest rates make it even more difficult to mobilise investments that could alleviate supply shortages. And as the Roosevelt report and my earlier Brookings Institution report with Anton Korinek show, there are many other ways that higher interest rates may exacerbate inflationary pressures.

Well-directed fiscal policies and other, more finely tuned measures have a better chance of taming today’s inflation than do blunt, potentially counterproductive monetary policies. The appropriate response to high food prices, for example, is to reverse a decades-old agricultural price-support policy that pays farmers not to produce, when they should be encouraged to produce more.

Likewise, the appropriate response to increased prices resulting from undue market power is better antitrust enforcement, and the way to respond to poor households’ higher rents is to encourage investment in new housing, whereas higher interest rates do the opposite. If there was a labour shortage (the standard sign of which is increased real wages – the opposite of what we are currently seeing), the response should involve increased provision of childcare, pro-immigration policies, and measures to boost wages and improve working conditions.

After more than a decade of ultra-low interest rates, it makes sense to “normalise” them. But raising interest rates beyond that, in a quixotic attempt to tame inflation rapidly, will not only be painful now; it will leave long-lasting scars, especially on those who are least able to bear the brunt of these ill-conceived policies. By contrast, most of the fiscal and other responses described here would yield long-term social benefits, even if inflation turned out to be more muted than anticipated.

The psychologist Abraham Maslow famously said: “To a man with a hammer, everything looks like a nail.” Just because the US Federal Reserve has a hammer, it shouldn’t go around smashing the economy.

Why Britain cannot build enough of anything

 The problem is bad rules, not bad people opines The Economist

Sep 1st 2022

Duncan sandys, a Conservative minister in the 1950s and 1960s, has two reasons to be remembered. The first is that he was the “headless man” being fellated by the Duchess of Argyll in a Polaroid photo, which emerged in divorce proceedings so vicious that they were turned into a bbc One drama earlier this year.

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The second reason is less salacious. In 1955 Sandys issued a circular that fundamentally changed Britain. It implored local councils to forbid building on the edge of cities in order “a) to check the further growth of a large built-up area; b) to prevent neighbouring towns from merging into one another; or c) to preserve the special character of a town”. The authorities had tried to restrict urban growth since the reign of Elizabeth I. Now they could.

Today all four nations of the United Kingdom have green belts. About 13% of England is so designated, including the surroundings of every major city. The girdle that encloses London is three times the size of the capital. A stroll through it takes in scrubland, pony paddocks and petrol stations. In “The Blunders of our Governments”, a book by Anthony King and Ivor Crewe, the policy is held up as a rare example of legislation achieving exactly what was intended.

The green belts do their jobs well, pushing development into the rural areas between them (see maps). Indeed, most parts of the planning system work as intended. Councillors retain democratic control over the planning system. Environmental watchdogs enforce their mandates fiercely. Stringent rules protect bats, squirrels and rare fungi. Courts ensure that procedures are followed to the letter. But the system as a whole is a failure. Britain cannot build.

In total, about 10% of gdp is spent on building, compared with a g7 average of 12%. England has 434 dwellings per 1,000 people, whereas France has 590, according to the oecd, a club of mostly rich countries. There is little slack in the market. In France, about 8% of dwellings are vacant at any one time. In England, the rate is barely 1%. Britain also struggles to build reservoirs and (despite boasts from successive prime ministers) nuclear power stations. With almost 500,000 people, Leeds is the largest city in Europe without a mass transit system. What has gone wrong?

The problem starts with the Town and Country Planning Act, which nationalised the right to build on land. Where once owners could do almost as they pleased, after its passage in 1947, local councils controlled what was built where. They have never relinquished that power. The planning system has more in common with an old eastern European command economy than a functioning market, argues Anthony Breach of Centre for Cities, a think-tank. “We do not have a planning system, we have a rationing system,” he says.

Even when councils approve development, other outfits can stop it. Natural England was created in 2006 with the aim of protecting flora and fauna. After a European Court of Justice ruling in 2018, it was tasked with ensuring “nutrient neutrality”, meaning any development could not increase phosphate or nitrate pollution in rivers. Natural England came up with a blunt solution: building could not go ahead unless developers could prove it would not lead to an increase in nutrient levels, a stipulation that few could provide.

The result was a near total freeze on house-building. Local politicians and developers, who had spent years in painful negotiations, were caught out. In total, about 14% of England’s land faced extra restrictions. One industry group argues that 120,000 houses were affected, or 40% of Britain’s annual housing target. Liz Truss, the likely next prime minister, has promised to scrap the requirement, but details are scant.

Newts present as many problems as nutrients. Anyone who harms a great crested newt while building can be jailed for up to six months. Bats are a nightmare for anyone renovating or developing (enterprising nimbys sometimes install bat boxes in order to attract them to a potential site). Protected under law, it is a crime to harm a bat or destroy its roost. A full report, which involves ecologists scouring a property with bat-hunting microphones plugged into iPhones, can cost £5,000 ($5,800).

If a roost must be destroyed, a like-for-like replacement must be installed. hs2, a railway line, was forced to build a £40m bat tunnel to stop the creatures being squished; its route is lined with bat-houses, which are large enough for humans. For developers, the rules are an expensive annoyance. For bats, however, the legislation has been a success. Numbers of the common pipistrelle have almost doubled since records began in 1999.

Some schemes do not survive contact with environmental objections. A planned nuclear power station in north Wales was rejected by the planning inspectorate in 2019 partly on the ground that it might affect a local population of terns. Inspectors ruled that “it cannot be demonstrated beyond reasonable scientific doubt that the tern colony would not abandon Cemlyn Bay”. That the terns had existed next to a previous nuclear power station was little defence. Inspectors also worried about the effect construction would have on the dominance of the Welsh language.

Even small housing estates now require reams of impact assessments and consultations. A planning application used to involve a single thick folder, says Paul Smith, the managing director of Strategic Land Group, which helps customers win planning permission. Now it is a thicket of pdfs, often running to thousands of pages.

For a development of 350 houses in Staffordshire, a developer had to provide a statement of community involvement, a topographical survey, an archaeological report, an ecology appraisal, a newt survey, a bat survey, a barn owl survey, a geotechnical investigation to determine if the ground was contaminated, a landscape and visual impact assessment, a tree survey, a development framework plan, a transport statement, a design and access statement, a noise assessment, an air quality assessment, a flood risk assessment, a health impact assessment and an education impacts report. These are individually justifiable, yet collectively intolerable.

See you in court

Make an error, however, and a legal challenge will follow. Anyone affected by a decision and able to afford a judicial review can challenge a planning decision. For a group of motivated, well-off nimbys, whipping together £20,000 for a review is easy enough. In Bethnal Green, in east London, a mulberry tree blocked the conversion of a Victorian hospital into 291 flats. Dame Judi Dench, an actor, was roped in to support the tree, which was so frail it required support from a post haphazardly nailed onto one of its branches.

After a campaign, the mulberry was in 2018 designated a veteran tree, which gives it special legal rights. (The number of signatories to save the tree matched the then population of Bethnal Green.) Although the developer had proposed moving the plant, a judge ruled that the council had not properly considered the danger that it might not survive: “A policy was misinterpreted; a material consideration was ignored.” The site sits derelict today.

Councils behave rationally when it comes to development. They levy no income tax or sales tax, and cannot even fund all their operations from property taxes, known as council tax. In all, local government imposes taxes worth less than 2% of gdp, according to the oecd. So more development does not equal much more money for better services. But it does equal more complaints. Councillors often enjoy majorities of just a few dozen votes. A well-organised campaign can replace an entire council, as happened in Uttlesford, in Essex. The result is that local councils are “a bottleneck on national economic growth”, argues a joint paper by the Centre for Cities and the Resolution Foundation.

The government in Westminster can usually override local objections. “When the state decides to act, it has unlimited power,” says Andrew Adonis, a Labour peer, who oversaw the introduction of hs2. Projects such as hybrid bills allow the government to bypass the planning system, turning Parliament into a kind of planning committee. The process is so arduous that sitting on the committee is often a form of punishment from the whips who enforce party discipline. But the benefit is that courts do not challenge primary legislation. Judicial review claims bounced off hs2 like stones off a tank.

Even when the government acts, it is often cautious. A plan to turn a quarry in Kent into a settlement of 15,000 homes was one of the most ambitious schemes, when announced by George Osborne, the then-chancellor, in 2014. Yet it is around a seventh of the size of Milton Keynes, a maligned but highly successful new town begun in the 1960s.

Larger schemes, such as a push for a million homes stretching between Oxford and Cambridge, with a new railway and motorway linking them, have been ditched due to local opposition. “We were a bit out of puff,” admits a cabinet minister. Greg Smith, a Tory mp, had already put up with hs2 slicing through his constituency, and it seemed unfair to subject him to more building. In Britain, pork barrel politics works in reverse, with mps keen to keep things out of their constituencies.

As a result, Britain’s most productive region is shackled. Burgeoning life-sciences firms fight for scarce lab and office space while world-class researchers live in cramped, expensive homes. The average house price in Oxford, £474,000, is about 12 times average incomes. Given the opposition of local councils and local mps to housebuilding, though, it can hardly be said to be against voters’ will.

Britain is rare in that the Treasury functions as both a finance ministry, keeping a close eye on spending, and an economic ministry, investing for the future. Thriftiness tends to trump investment. “[The Treasury] can add up but they can’t multiply” as Diane Coyle, an economist, puts it. It shackles big infrastructure projects, balking at upfront costs even if there are large returns later on.

The result is false economies. hs2, a £100bn project to connect London to Birmingham and then Manchester, Sheffield and Leeds, was intended mostly to add capacity to Britain’s crowded railways, not (despite the name) to speed journeys up. The government recently cut the eastern leg of the scheme to save money. That it was the most beneficial part of the scheme—the eastern leg to Leeds and Sheffield had a benefit-to-cost ratio of nearly 5.6:1, compared with 2.6:1 on the western leg between London, Birmingham and Manchester—was overlooked. Joseph Bazalgette, the Victorian responsible for London’s sewer system, is said to have argued that: “We’re only going to do this once and there’s always the unforeseen”. Now, the opposite principle applies.

Political capital is less fungible than the financial kind. When it comes to building things in Britain, there is usually no alternative scheme ready to go. If a big project is scrapped, the political capital spent on forcing through its approval cannot be instantly reallocated. The slow process of winning support at a local and national level must start anew. In the meantime, nothing is built.

And Westminster can be capricious. In 2022, after years of argument, Transport for London won permission to build 351 flats on land it owned at Cockfosters Underground station. Grant Shapps, the transport secretary, blocked the development because it removed too many car parking spaces. The Leeds Supertram Act was passed in 1993. Three decades later, Leeds possesses no tram, super or not, as a series of governments refused to fund the project. In 2016 the government rejected a proposal for a trolleybus, in part because it did not think the route would reduce inequality within the city.

Scepticism among nimbys is often justified. Post-war town planners botched city centres, bulldozing through objections. Birmingham’s Victorian centre was carved up to make way for ring roads that still throttle the city. London narrowly avoided a similar fate. New developments, such as Nine Elms, manage to be expensive while looking cheap. Outside big cities, development is often limited to boxy housing estates, which are notorious for poor building quality. A Welsh property surveyor has amassed 560,000 followers on TikTok by angrily taking viewers through snags in newbuilds. (“Check out what this absolute melt has done with this hinge,” he almost screams in one video. “That is absolutely ridiculous.”)

In Oxfordshire a group of residents have spent almost a quarter of a century fighting attempts to build a reservoir. The Environment Agency and a public inquiry sided with the residents over Thames Water. The objectors are shrewd, motivated and well-versed in water regulation. The chairman of the Group Against Reservoir Development (gard) is a retired nuclear scientist; his predecessor was a brigadier. But after a summer of drought, in which Thames Water had to implement a hosepipe ban, the victory rings a little hollow.

Efforts are being made to convert the unbelievers. New planning legislation offers residents the chance to propose their own development and, in effect, approve it themselves via street votes. The government is trying to improve design standards, hoping that beautiful buildings will attract less opposition. Those who put up with infrastructure, whether wind turbines or a reservoir, may benefit from free energy or water bills under one scheme floated by ministers.

Officials are also toying with a net-zero trump card. Projects deemed crucial to making Britain emissions neutral by 2050 would be able to ride roughshod over many obstacles. At the moment policy aimed at protecting the environment hinders projects that should help the climate. The government protects flora and fauna because voters want it; circumventing such rules can only be done in the name of the environment, runs the logic.

Building is binary, however. If something is built, those who oppose it will be unhappy; if it is scrapped they will be delighted. There is little incentive to meet halfway, or to accept a payoff. “This is not some sort of poker game where we demand huge compensation,” said Derek Stork, who chairs the reservoir-killing gard. Britain cannot build. But that is just the way voters want it.

Energy Price Rises are a result of speculation and not increase in price of gas and oil

 

Stagflationary global debt crisis looms – and things will get much worse

 


The global financial and economic outlook for the year ahead has soured rapidly in recent months, with policymakers, investors and households now asking how much they should revise their expectations, and for how long. That depends on the answers to six questions.

First, will the rise in inflation in most advanced economies be temporary or more persistent? This debate has raged for the past year but now it is largely settled: “Team Persistent” won, and “Team Transitory” – which previously included most central banks and fiscal authorities – must admit to having been mistaken.

The second question is whether the increase in inflation was driven more by excessive aggregate demand (loose monetary, credit, and fiscal policies) or by stagflationary negative aggregate supply shocks (including the initial Covid-19 lockdowns, supply-chain bottlenecks, a reduced US labour supply, the impact of Russia’s war in Ukraine on commodity prices, and China’s “zero-Covid” policy). While demand and supply factors were in the mix, it is now widely recognised that supply factors have played an increasingly decisive role. This matters because supply-driven inflation is stagflationary and thus raises the risk of a hard landing (increased unemployment and potentially a recession) when monetary policy is tightened. That leads directly to the third question: will monetary-policy tightening by the US Federal Reserve and other major central banks bring a hard or soft landing? Until recently, most central banks and most of Wall Street occupied “Team Soft Landing”. But the consensus has rapidly shifted, with even the Fed Chair, Jerome Powell, recognising that a recession is possible, and that a soft landing will be “very challenging”.

Moreover, a model used by the Federal Reserve Bank of New York shows a high probability of a hard landing, and the Bank of England has expressed similar views. Several prominent Wall Street institutions have now decided that a recession is their baseline scenario (the most likely outcome if all other variables are held constant). In the US and Europe, forward-looking indicators of economic activity and business and consumer confidence are heading sharply south.

The fourth question is whether a hard landing would weaken central banks’ hawkish resolve on inflation. If they stop their policy-tightening once a hard landing becomes likely, we can expect a persistent rise in inflation and either economic overheating (above-target inflation and above potential growth) or stagflation (above-target inflation and a recession), depending on whether demand shocks or supply shocks are dominant.

Most market analysts seem to think that central banks will remain hawkish but I am not so sure. I have argued that they will eventually wimp out and accept higher inflation – followed by stagflation – once a hard landing becomes imminent because they will be worried about the damage of a recession and a debt trap, owing to an excessive buildup of private and public liabilities after years of low interest rates.

Now that a hard landing is becoming a baseline for more analysts, a new (fifth) question is emerging: Will the coming recession be mild and short-lived, or will it be more severe and characterised by deep financial distress? Most of those who have come late and grudgingly to the hard-landing baseline still contend that any recession will be shallow and brief. They argue that today’s financial imbalances are not as severe as those in the run-up to the 2008 global financial crisis, and that the risk of a recession with a severe debt and financial crisis is therefore low. But this view is dangerously naive.

There is ample reason to believe that the next recession will be marked by a severe stagflationary debt crisis. As a share of global GDP, private and public debt levels are much higher today than in the past, having risen from 200% in 1999 to 350% today (with a particularly sharp increase since the start of the pandemic). Under these conditions, rapid normalisation of monetary policy and rising interest rates will drive highly leveraged zombie households, companies, financial institutions, and governments into bankruptcy and default.

The next crisis will not be like its predecessors. In the 1970s, we had stagflation but no massive debt crises because debt levels were low. After 2008, we had a debt crisis followed by low inflation or deflation because the credit crunch had generated a negative demand shock. Today, we face supply shocks in a context of much higher debt levels, implying that we are heading for a combination of 1970s-style stagflation and 2008-style debt crises – that is, a stagflationary debt crisis.

When confronting stagflationary shocks, a central bank must tighten its policy stance even as the economy heads toward a recession. The situation today is thus fundamentally different from the global financial crisis or the early months of the pandemic, when central banks could ease monetary policy aggressively in response to falling aggregate demand and deflationary pressure. The space for fiscal expansion will also be more limited this time. Most of the fiscal ammunition has been used, and public debts are becoming unsustainable.
 
Moreover, because today’s higher inflation is a global phenomenon, most central banks are tightening at the same time, thereby increasing the probability of a synchronised global recession. This tightening is already having an effect: bubbles are deflating everywhere – including in public and private equity, real estate, housing, meme stocks, crypto, Spacs (special purpose acquisition companies), bonds, and credit instruments. Real and financial wealth is falling, and debts and debt-servicing ratios are rising.

That brings us to the final question: will equity markets rebound from the current bear market (a decline of at least 20% from the last peak), or will they plunge even lower? Most likely, they will plunge lower. After all, in typical plain-vanilla recessions, US and global equities tend to fall by about 35%. But because the next recession will be stagflationary and accompanied by a financial crisis, the crash in equity markets could be closer to 50%.

Regardless of whether the recession is mild or severe, history suggests that the equity market has much more room to fall before it bottoms out. In the current context, any rebound – such as the one in the last two weeks – should be regarded as a dead-cat bounce, rather than the usual buy-the-dip opportunity. Though the current global situation confronts us with many questions, there is no real riddle to solve. Things will get much worse before they get better.

There is ample reason to fear big economies such as the US face recession and financial turmoil writes Nouriel Roubini in The Guardian

Prof. Richard Wolff: How to Fix Inflation

 

Solutions for Inflation? Capitalism Faces a Dead End?

 

Global Capitalism: Inflation: Causes, Effects, & Outlook

 

Bullshit Economics to explain Supply Chain Failures

 

1 A new economic era: is inflation coming back for good?

 Chris Giles in The FT 

The December meeting of the Federal Reserve’s most important economic committee was routine. Policymakers agreed that the economy could cope with rising levels of spending “without any strong general upward pressure on prices”. 

Although prices of a few raw materials were rising sharply, “finished goods have not been subject to pervasive upward cost pressures”. 

Generalised inflation, the committee concluded, was not a serious concern. 

This meeting of the Federal Open Market Committee was held on December 15 1964, just two weeks before the start of a 17-year period the Fed now dubs The Great Inflation. Inflation: 

Turning points in price trends tend to occur just at the moment when the authorities and expert opinion dismiss the risks. The current consensus is that price rises in commodities and goods markets have clear pandemic-related explanations and that the risks of a resurgence in global inflation remains remote. 

Three decades after the authorities in advanced economies managed to suppress the beast, they remain confident they are in control. The mantra of the moment is summed up by Andrew Bailey, Bank of England governor, who likes to say he is watching inflation “extremely carefully” but not worrying. 

This view is still the mainstream but it is losing supporters. One notable recent defector is Roger Bootle, author of the book The Death of Inflation, who spotted the coming decline in price rises in the mid 1990s. He is now worried. “Financial markets are going to have to get used to the return of troublesome issues that had, until recently, seemed long dead,” Bootle wrote in May. 

Central bankers have not had to deal with an inflation problem during their careers. Having averaged around 10 per cent a year in the 1970s and 1980s, global inflation rates fell to an average close to 5 per cent in the 1990s in the rich world countries of the OECD, 3 per cent in the 2000s and 2 per cent in the 2010s. The question today is whether their view is complacent. Is the world entering another inflationary era? 

While many households think the definition of price stability would be an absence of inflation, economists and policymakers favour a gentle annual increase in prices of around 2 per cent. This reduces the risk that an economic crisis could spark a deflationary spiral with spending, prices and wages all falling, raising the real burden of debts and further hitting spending. Holger Schmieding, chief economist of Berenberg Bank, explains that a little inflation also greases the wheels of the economy, allowing declining sectors to fall behind gracefully. 

“Higher inflation eases economic adjustments as it creates more scope for changes in relative wages without a need for an outright fall in wages in sectors under pressure,” he says. 

In most advanced economies — the US, the eurozone and Japan — central banks have fallen short of meeting their targets of inflation of around 2 per cent despite having slashed interest rates to zero and having created trillions of dollars, euros and yen, which has been pumped it into their economies by purchasing government debt. A modest rise in inflation therefore would be welcomed by central banks, which have generally been delegated the task of achieving price stability. 

And until this year, the main economic concern regarding prices was the risk that countries were turning Japanese and might soon emulate the nation’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, former Fed chair, who argued in 2002 that “under a paper-money system, a determined government can always generate higher spending and hence positive inflation”. 

But this view of the world has turned on its head in 2021. A new whatever-it-takes borrowing and spending programme by the Biden administration, enforced savings during the coronavirus crisis giving households additional firepower, bottlenecks in the supply of goods and a reversal of longstanding downward pressures on global wages and prices have rekindled fears of excessive inflation. 

No one is talking about hyperinflation of the sort seen in Weimar Germany in 1923 or Latin America in the 1980s or even the 10 per cent global rate of the 1970s, but a creeping rise to persistent levels of generalised price increases not seen in a generation. When the April rate of US inflation jumped to 4.2 per cent, financial markets swooned. 

The new concern about a return to inflation is not just the result of immediate economic forces but also reflects longer-term, underlying changes in the structure of the global economy. The aggressive economic stimulus is being adopted at the very moment when the global economy is feeling the impact of ageing populations and the maturing of China’s 40-year transition. 

Moreover, history also tells us that neither politicians, economists nor policymakers can guarantee the world will maintain low and stable inflation. As the Fed’s experience from the 1960s demonstrates, turning points in inflation arrive with little warning. Unlike in the US, where there was no fear of inflation after the second world war, concern about inflation was “always rumbling on” following devaluations of sterling and higher import prices in the UK during the full employment years of the 1950s and 1960s, according to Nick Crafts, professor of economic history at Sussex university. 

But it only really took off in the 1970s after the first Opec oil shock and a switch in government policy from austerity to “a massively excessive stimulus, pushing the economy beyond any reasonable estimate of the sustainable level of unemployment”, Crafts adds. 

Research from Luca Benati, professor at Bern university, suggests that the world’s faith in central bankers being able to tame any similar episodes is probably overblown. The UK’s inflationary pressure in the 1970s was so strong, he found, that when he ran history again in multiple simulations assuming an independent central bank is in charge of controlling prices, inflationary forces would have been more powerful than any likely action by a Bank of England with an independent Monetary Policy Committee. In the 1970s, it would have had only a “limited impact” on quelling price rises which reached an annual rate of 26.9 per cent in 1975. 

According to Karen Ward, chief European market strategist at JPMorgan Asset Management, this means the Bernanke doctrine still stands and should not be forgotten. “We’ve always assumed that the structural supply side enhancements such as technology and globalisation are so great that we could never overwhelm them with demand, but it still must be the case that you can overwhelm supply with demand and ultimately generate inflation,” she says. 

It is exactly this fear which is raising inflation rate expectations in the US and Europe at the moment. Alongside a recovery of energy prices to pre-Covid levels, there has been a shortage of microchips, wood products, many metals and even cheese. These have been the proximate causes of higher inflation, but financial markets worry that the ultimate cause has been the pandemic-related fiscal and monetary stimulus which has led to a much faster economic recovery in advanced economies than was thought possible at the end of 2020. 

With economic policy pressing harder on the accelerator than at any time in recent history, spending could exceed the capacity of economies to provide goods and services, especially if the coronavirus crisis and government support have left people less willing to work, creating labour shortages and significant pressure on companies to raise wages. 

Such is the potential imbalance between rampant demand and more constrained supply, especially in the US, some supporters of centre-left policy ideas say that warning lights are flashing. Larry Summers, Treasury secretary in the Clinton administration, thinks policy has become far too lax, repeatedly criticising the “dangerous complacency” over inflation of today’s policymakers in recent weeks. 

While the White House has hit back, saying “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, current Treasury secretary, has acknowledged the possible need for interest rates to rise “to make sure that our economy doesn’t overheat”. 

The policy shift has come at a point when economists generally accept that some of the big global forces holding prices down are much weaker than they were. In the 1990s and 2000s, globalisation led to a huge transfer of the production of goods from high wage economies to China and eastern Europe, accelerating a decline in the power of workers in advanced economies to force their employers to pay them more, keeping prices low. 

But these forces are at a turning point, according to Charles Goodhart, former chief economist of the Bank of England, and an author of the book The Great Demographic Reversal. The long boom in the size of its workforce has ended and its population is on the verge of falling for the first time in decades. Goodhart says that fewer new workers becoming integrated into the global labour force at a time of shrinking workforces in advanced economies as populations age will raise the pressures on companies to push up wages, increasing underlying inflationary pressures. 

The change in demographic pressures have already been around for a decade and are intensifying, Goodhart says. He had been wary of putting a date on the coming inflation, saying that the world is likely so see rising inflationary pressure within five years and “we are fairly sure it would have happened by 2030”. 

That was before Covid struck. Now, he says the underlying pressures, alongside more stimulative policies and Covid-related restrictions in supply, have brought forward the moment. “We tend to think that because of supply constraints in particular, it’s 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 build-up of large monetary balances . . . combined with large continued fiscal expansion.” 

Turning to specific examples of prices he expected to see rise, Goodhart notes how the added demand for holidays in the UK would push up the prices of holiday rentals, hotels and even ice cream this summer. “You’d have to be a saint not to raise your prices,” he says. 

Demographic pressures are not something that can be reversed quickly, nor he argues can the forces of globalisation, which have gone into retreat having become politically unpopular in many advanced economies. Again, this is most acute in the US where economists such as Adam Posen, president of the Peterson Institute for International Economics, urges Americans to “embrace economic change rather than nostalgia” in domestic production, especially in manufacturing, as a means to improving living standards and promoting non-inflationary growth. 

So far, however, although financial market expectations of inflation have risen sharply in 2021, mainstream policymakers are remaining calm. 

There is increasing chatter in the Fed that at some point the current members of the interest-rate setting committee need to think about scaling back the pace of money creation and purchases of government bonds. But the view is that inflation is recovering to more normal levels and the US central bank has pledged to keep policy ultra accommodative until it achieves a more inclusive recovery. 

This is the right approach, says Laurence Boone, chief economist of the OECD in Paris, a view which chimes with similar attitudes in central banks around the world. “It’s too early to ring the alarm bells about inflation,” she says. “That doesn’t mean one doesn’t have to watch what’s happening and we’re seeing frictions with the reopening of demand and supply after the crisis . . . but the right policy is to ease tensions on the supply side more than central bank action [to quell inflationary pressures].” 

In most economies, there remains significant slack in the labour market, she adds, and the big demographic pressures could be eased significantly with later retirement, while other parts of Asia and Africa would be delighted to integrate into the global economy as China did. 

Boone’s view still represents the consensus opinion among economists and there is considerable confidence in central banks that any rise in inflation this year will be temporary and easily tamed without having to tighten policy significantly. 

But, for the first time in many decades, there is the possibility that a significant turning point has arrived, that price rises will be more than a flash in the pan and something more difficult to control.