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Axel Weber urges economic policymakers not to underestimate the pandemic's potential to trigger faster price growth

Axel Weber urges economic policymakers not to underestimate the pandemic's potential to trigger faster price growth

Current forecasts by many banks, central banks, and other institutions suggest that inflation will not be a problem in the foreseeable future. The International Monetary Fund, for example, expects global inflation to remain subdued until the end of its forecast horizon in 2025. But could those who heed these forecasts be in for a rude awakening?

Economic models have long been notoriously inaccurate in predicting inflation, and COVID-19 has further complicated the challenge. While economic forecasters calibrate their models using data from the last 50 years to explain and predict economic trends, today’s economic conditions have no precedent in that period. Today’s low inflation forecasts are thus no guarantee that inflation will actually remain low.

Even without additional inflationary pressure, reported inflation rates will rise significantly in the first five months of 2021. By May, UBS expects year-on-year inflation to rise above 3% in the United States and toward 2% in the eurozone, largely owing to the low base in the first half of 2020, when pandemic-related lockdowns began. The higher rate therefore does not point to rising inflationary pressure, though an increase above those levels would be a warning sign.

Many argue that the COVID-19 crisis is deflationary, because pandemic-mitigation measures have affected aggregate demand more adversely than aggregate supply. In the first months of the crisis, this was largely the case: in April 2020, for example, oil prices fell toward, or even below, zero.

But a detailed look at supply and demand reveals a more nuanced picture. In particular, the pandemic has shifted demand from services to goods, some of which have become more expensive, owing to production and transport bottlenecks.

In current consumer-price calculations, rising goods prices are partly offset by falling prices for services such as air travel. But in reality, pandemic-related restrictions mean that consumption of many services has fallen sharply; significantly fewer people are flying, for example. Many people’s actual consumption baskets have thus become more expensive than the basket statistical authorities use to calculate inflation. So, true inflation rates are currently often higher than the official figures, as reports have confirmed.

Once governments lift mobility restrictions, services inflation also may increase if reduced capacity – as a result of permanent closures of restaurants and hotels, for example, or airline layoffs – are insufficient to meet demand.

The unprecedented fiscal and monetary expansion in response to COVID-19 may pose an even greater inflation risk. According to UBS estimates, aggregate government deficits amounted to 11% of global GDP in 2020, more than three times the average of the previous ten years. Central banks’ balance sheets increased even more last year, by 13% of global GDP.

Government deficits in 2020 were thus indirectly financed by the issuance of new money. But this will work only if enough savers and investors are willing to hold money and government bonds at zero or negative interest rates. If doubts about the soundness of these investments were to prompt savers and investors to switch to other assets, affected countries’ currencies would weaken, leading to higher consumer prices.

Previous episodes of excessive government debt almost always ended with high inflation. Inflation caused by a loss of confidence can emerge quickly and in some cases at a time of underemployment, without a preceding wage-price spiral.

Although expansionary monetary policy after the 2008 global financial crisis did not lead to increasing inflation, this is no guarantee that price growth will remain low this time. After 2008, newly created liquidity flowed mainly into financial markets. But central banks’ current balance-sheet expansion is triggering large money flows into the real economy, through record fiscal deficits and rapid credit growth in many countries. Moreover, the monetary-policy response to the pandemic was much faster and more substantial than in the last crisis.

Demographic shifts, increasing protectionism, and the US Federal Reserve’s de facto increase last year of its 2% inflation target are among other factors that could lead to higher inflation in the longer term. Although these structural factors are unlikely to trigger a surge in price growth in the short term, they could still facilitate it.

A sharp rise in inflation could have devastating consequences. To contain it, central banks would have to raise interest rates, which would create financing problems for highly indebted governments, firms, and households. Historically, central banks have mostly been unable to resist government pressure for sustained budget financing. This has often resulted in very high rates of inflation, accompanied by large losses in the real value of most asset classes and political and social upheaval.

In recent months, commodity prices, international transport costs, stocks, and Bitcoin have all risen sharply, and the US dollar has depreciated significantly. These could be harbingers of rising consumer prices in the dollar area. With inflation rates highly correlated internationally, higher inflation in the dollar area would accelerate price growth worldwide.

Too many are underestimating the risk of a rise in inflation, and sanguine model-based forecasts do nothing to alleviate my fears. Monetary and fiscal policymakers, as well as savers and investors, should not allow themselves to be caught out. In 2014, former Fed Chair Alan Greenspan predicted that inflation would eventually have to rise, calling the Fed’s balance sheet “a pile of tinder.” The pandemic could well be the lightning strike that ignites it.


Axel A. Weber, a former president of the Deutsche Bundesbank and former member of the Governing Council of the European Central Bank, is Chairman of the Board of Directors of UBS Group AG. Copyright: Project Syndicate, 2021, and published here with permission.

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54 Comments

30
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But inflation isn't low. It's hidden in stats that give too high a weighting to plastic trinkets.

31
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Don't worry about food and rent, just eat your flatscreen TV and live in the box.

Shame they don't have crying with laughter emojis here. I suppose it'd lower the tone, but your comment was worth one. LOL.

20
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Maybe Harvey Norman will start doing 60 months interest free on groceries?

That could be a very prescient comment!

My impression is that China (where all our plastic stuff is made) appears to be running out of low cost the labour needed to expand on their make-everything-cheaply business model. The plastic trinket facet of our inflation basket soon to be heading upwards in ways not seen in a generation. Inflation may be coming back with a vengeance.

Agreed

19
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How much cash do you need to save from your (largely unmoved) salary to provide interest income to survive now as compared to 10 years ago?
Bucket loads more.
We have massive inflation by this one simple test.
But mr orr full wants to keep printing regardless, so they will keep using bs figures.

17
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Absolutely this. I am seeing elderly people with decent cash reserves being torn apart due to low interest rates. One could live a decent life with $1m in the bank not so long ago. That same $ today is yielding 1% at best (BEFORE TAX!!). Our money is being debased at a horrendous rate.

Adrian Brrrrrrrrrr, CPI is bull****.

Fix the money fix the world.

11
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If you own your own home and live a pretty normal lifestyle I have always imagined that the Govt Super is (almost) enough once you reach about 70. And if you have a million in the bank (and are 70) you can spend an extra 70K a year for the next 15 years and still have some left. If you are still alive at 85 there is almost no way you will be able to spend more than the Govt Super so the situation for most retirees with their own home is not as dire as it seems. Just don't stress about your reducing bank balance. you can't take it with you!

14
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..easily said. Try telling that to someone who has kids in their 20s who are getting smashed by this legalised theft and go backwards as they save.

It amazes me that people are still having multiple children in the current financial environment. Being a late 20s couple, we've decided against it largely due to finances. Surely it can't continue on this trajectory

10
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A very sad comment about modern life.

I regularly ponder about the eff'd up world I've brought two teenagers into and if I could go back in time, for their sake would I make the same choices.

I've heard similar from a lot of couples, deciding not to have children. Apparently vasectomies are all the rage.
Anyway, if we need more people how about Papua New Guinea, they have a huge surplus, plus they are great reproducers, they will boost NZ's lacklustre population growth.

That's just it. We don't need more people

I have genuine concern for you. but seriously Just do it. I put off having our first until I was mid 30's & now wish I'd done it sooner. Honestly its not about the money, but more the energy levels needed to raise kids. They are little energizer bunnies. when you get to 30 your body starts slowing down. Just my personal opinion. Also kids are amazing!

yep the trick is to own your own home, or to pretty much have it owned. Something i think will be a hard thing to achieve with the current prices being paid, and if interest rates go up just a percent or two, then it will be out of reach for many. But hey that's for the government in the next ten years to worry about so keep on partying at Jacinda and Grants place.

Karl S,

Do you have good figures on just how many retirees have $1m in cash-or anything like it?

I certainly don't have access to those figures, but my feeling is that as a percentage of the retired population, it would be low.

linklater01... dunno. I just got the $1M figure from the post I was replying to. But I would say quite a few would end up with a million from downsizing or selling and moving into a retirement village. A million is not what it used to be.
My main point (which probably wasn't relayed very well) was that we don't need to worry too much about retirees. Most do not need to spend much and they obv don't need to save. It is the young people we need to be concerned about. I know I will be able to live off Govt Super if I have to.

The amount required goes up each year, driven in part by inflation (2%?), and likely lower returns on stocks/housing (yield, not capital gain). My current estimate is about the same as you Karl, $1m. This allows sirloin steak on the weekend, a mediocre car, med insurance (parents pay $750/month) and a bit of travel. I'd build some fat into it to cover the hip replacement, dental crown, roof replacement and targeted $1.2m as a final figure. Any other thoughts?

Nah you have summed it up right

Govt super goes up with wages each year (I think). Obviously living off super becomes tough if you don't own your home but I guess the AS will help a lot. IMO most people need less than they think in retirement because activities like holidays, sports, pub visits etc become less attractive.

Most suggest a total retirement nest egg of 25x annual expenses required to live a comfortable (not exuberant) lifestyle in retirement.

Not sure about that Albert. If your annual expenses were 40K PA you would need exactly $1M. If you started with a million at age 65 and earned only 2% PA average return (very very realistic/conservative long term your nest egg would only drop 20K in the first year, 19K in the second year etc so you would need to live till about 110 to run out of money.
Two big conditions to this calc though. Firstly, we are ignoring inflation and secondly we are ignoring that everybody in NZ (currently) receives Govt Super at 65. With Govt Super and my own home I am sure I will only need 500 or 600K max on retirement. And if you think you might really live an unusually long life (and don't know how much you need to put away) an annuity is a safe option.

Yes, but is this "mediocre" lifestyle trying to live off the interest or includes spending the capital? The capital should be spent as a priority for a comfortable life, not deemed as essential to be kept intact for inheritance purposes - and that includes the value of the house (that's what reverse mortgages are for (much) later in life i.e. nearer 80+ not 65)

Agree. It is amazing how many over 70s are uncomfortable with a reducing net worth when they will never spend it all. I promised myself I would never work again (or actively spend time trying to make money) once I had enough money to last me my lifetime and am comfortable with my net worth reducing every year till I die. It is not how much money you die with, it is how young you were when you stopped selling your life (working) that matters. Can't take it with you.

Usury is a sin, the elderly should know this.

I can attest to that.

16
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Inflationary pressures are a huge threat to the NZ economy, with the only tool known to have an immediate dampening effect is raising interest rates. The stimulus injected into the economy was a reaction to a perceived looming economic shock - and if this shock doesn't happen then what is the result of all this printed cash? The natural economic cycle of growth and decline has been stopped, and now inefficient businesses remain solvent instead of going bust as they should have, whilst every man & his dog has become a self-proclaimed ''property investor'' alongside their day job as the plummeting interest rates fuel a housing orgy.
If in 5yrs time the interest rates are at +5% how would this impact the NZ economy? We are stockpiling dead businesses & they will pop all at once, creating unemployment and a loss of consumer confidence and spending. Assuming many people will fix a mortgage this year for a 5yr term, we can only speculate at what happens when these terms finish.
But by then Jacinda will be chastising us from a seat on a global council and her band of merry spenders will be nowhere to be seen. Welcoming in another 25yrs of a National government who will once again use mass immigration to pretend to grow the economy.

A stampede out of NZ and less and less people will want to come here to live https://www.stuff.co.nz/travel/kiwi-traveller/117213477/new-zealand-almo... note this article is precovid before Beetroot and Fat Controller got stuck in

Well, that article brightened my day, not.
I don't mind being a furniture scavenging cut-backer, but I'm starting to get the feeling that pretty soon I'll have to make some tougher choices.

Will it mean increase in interest rates for deposits with the Banks ? Or, just extra margin for the Banks on lending ?

If...and the if is huge, the ability to demand wage increases eventuates then there may be inflation but even if so the central banks will not move until the last possible moment on interest rates as when they increase them the cascade of defaults will begin....such is a liquidity trap.

Oil price has been ticking up for some time. Oil drives everything.

Yes. About 0.20c a ltr more at the pump than a couple of months ago. 50ltrs/$10 a week
$500 bucks a year. A lot of money for some people who need to commute and work for a living.

It impacts everything yes but the price is flexible....if demand drops it adjusts quickly...wages not so.

When you pour money into the economy but the supply remains the same, the more money people will offer for the same goods. That's inflation. Since covid there is even less supply of goods in that equation

Currently (and for decades past) the inflation is asset inflation which is understandable.
We have since the 80s increasingly had (western) economies run by rentiers for rentiers, production off shored to low wage economies so no opportunity to increase productivity or leverage to increase wages....unfortunately for the rentiers too many joined their game and worked out there was no future in productive endeavour...the system is collapsing under the over extraction of rents.

Inflation, inflation everywhere but pity Adrian’s eyes doesn’t see very well with all his ego crowding his vision.

No wonder Mrs Beetroot "likes isolated, silent places away from home"

So if we dont lower OCR, our dollar will go up and exporters kneecapped. Orr has to follow the trend.

We don't need to export, simply print more cash and bid up houses so everyone feels riche

We need to export if we wish anything we cannot produce ourselves....which unfortunately is quite a lot

Govt spending has increased and this has increased the amount of money in circulation. However, Govt is a minor player compared to the banks who are pumping credit money into the economy - easily out-pacing Govt spending. It is the bank's splurge of credit money (coupled with low interest rates and buyer confidence) that is driving up house prices. It is credit money that is also driving NZ household debt as a % of GDP back to 2008 levels (what happened next?) https://tradingeconomics.com/new-zealand/households-debt-to-gdp

Jfoe, the Money Supply has been going up by tens of billions every month since March 2020, whereas bank lending has not been above 10 billion each month during that same time. So for example, in Dec the banks lent out 3 billion more in 2020 than in 2019. But RBNZ added tens of billions extra. If you look at the 5 year M3 chart, you can see a steep climb in the money supply March 2020 and then a new higher trajectory maintained, so i don't think we can pin this all on bank lending.

https://tradingeconomics.com/new-zealand/money-supply-m3

https://www.rbnz.govt.nz/statistics/c31

.

Inflation? don't know what your talking about...
My house increased in value by $60K in 1-2 months, but hey inflation is apparently ~1.4% - so all good right...??

Inflation is tied to increased costs of consumption... you don't eat your house.

Unless your taking food out of your own mouth to save a deport or pay some speculators debt servicing. It is the same wallet.

It's ludicrous to read the comments realising they can't differentiate between headline and core inflation in their agitprop.

The threat of rising interest rates? There is only 1 country in the world that sets that number for the rest of us and that isn't Aotearoa- but we can keep pretending.

Headline and core inflation both miss the rampant inflation in asset prices. Also there are three central banks that set our interest rates, but I'll concede the RBNZ isn't one of them.

The internet has helped to kill inflation. We crowdsource lower prices.

In NZ - raising inflation quickly being hide in housing, rental? foods? petrol? all ups - quick more of those subsidies, supplement - Until, most of NZ youth realised, they are just taken for a ride, cut your lost and move across for more meaningful life, join the brave, intelligence Nation across the ditch.. not to be shock though? - avoid Syd & MelB, unless the salary offer is six digits.