© Reuters. FILE PHOTO: The skyline with the banking district is photographed at sunset in Frankfurt on April 22, 2020. REUTERS / Kai Pfaffenbach
From Balazs Koranyi
FRANKFURT (Reuters) – Yes, inflation is back and you should probably be relieved if not happy.
That is the verdict of the world’s top central banks, hoping to have hit the sweet spot where healthy economies experience a gentle rise in prices – but not get out of hand.
Aided by huge government spending, central bankers have unleashed unprecedented monetary firepower in recent years to achieve this result. Anything else would suggest that the greatest experiment in modern central banking has failed.
Only Japan, which has tried and unsuccessfully tried to raise prices since the 1990s, remains in the doldrums.
For the other advanced economies, rising price pressures are moving the elusive goal of abolishing ultra-loose politics in sight and finally opening the prospect that the central banks, which had come to the fore during the global financial crisis, might finally step back.
The current rise in inflation is not without risk, of course, but comparisons with 1970s-style stagflation – a period of high inflation and unemployment with little or no growth – seem unfounded.
At first glance, current inflation rates do indeed look worrying. Price growth is already above 5% in the United States and could soon reach 4% in the euro zone, well above monetary policy targets and at a level that has not been achieved in well over a decade.
But hard evidence has yet to challenge the tale of many policy makers that this is mainly a temporary surge caused by the bumpy reopening of the economy after the pandemic.
“The current surge in inflation can be compared to a sneeze: the reaction of the economy to the raising of dust in the wake of the pandemic and the subsequent recovery,” said the board member of the European Central Bank, Isabel Schnabel.
So if inflation settles at a higher level after the “sneeze”, central banks should be happy because they have spent most of the last decade raising, not lowering, inflation.
Talks with over half a dozen central bankers inside and outside the records suggest that price pressure is finally building up and the normalization of politics, which has been taboo for years, is back on the agenda.
“If inflation doesn’t rise now, it never will,” said one politician who refused to be named. “These are the perfect conditions, that’s what we worked for.”
The central banks are already reacting. Norway, South Korea and Hungary, among others, have already hiked interest rates, while the US Federal Reserve and the Bank of England have made it clear that a move is imminent.
Even the ECB, which has been below its inflation target for a decade, is preparing to take back measures from the crisis soon as the markets now price in a rate hike in late 2022-early 2023, the first such measure since 2011.
NOT THE 70’S
Stagflation appears unlikely given the underlying factors driving inflation.
Wage increases, a requirement for inflation, remain anemic in Europe and below the rate of inflation in the United States. There is no evidence that companies plan to fully compensate workers for one-off price increases.
Unions have lost a lot of power over the years and wages are only part of their demands, along with free time and job security. Hence, they are unlikely to wield the bargaining power that drove wage growth and inflation into double digits in the 1970s.
The effects of exploding energy prices are also likely to be less than in the past. The energy sector’s share of total spending has declined over the past few decades, and the world has years of experience managing life with oil prices above $ 80 a barrel.
“The national economies have become much more independent of energy, both in terms of private consumption and industrial production,” said ING economist Carsten Brzeski. “Any increase in energy prices, as unwelcome as it is to producers, consumers and central bankers, will not have the same economic impact as it did in the 1970s.”
In fact, US economic output per unit of energy has more than doubled since 1975.
After all, the central banks are far from complacent. Most of them became independent because of inflation in the 1970s, and politicians are already aware of the dangers of unchecked price increases.
“We should be vigilant without fever,” said French central bank governor Francois Villeroy de Galhau on Tuesday.
THE NEXT CONCERN – DEBT
The headache begins when “temporary” inflation lasts too long and companies start adjusting both wages and prices, which sets in a temporary shock in underlying prices.
“The indicators do not suggest that long-term inflation expectations are dangerously untied,” said Atlanta Fed President Rafael Bostic. “But the episodic pressures could last long enough to resolve expectations.”
Unfortunately, there is no magic formula for determining how long is too long.
In fact, the real concern for the future may be something else: debt.
Governments borrowed huge sums of money to get out of the pandemic, and simple central bank policies keep this debt manageable.
US debt accounts for around 133% of gross domestic product, while in the euro zone it is around 100%, both above an average of 70% a little over a decade ago. Japanese debt is over 250% of GDP.
But even as debt levels have risen, the cost of servicing them has decreased given the extremely low interest rates. That means governments are more reliant than ever on central banks to keep interest rates close to rock bottom.
Central banks may be forced to choose between higher inflation or higher borrowing costs, which hold back growth.
“At the moment we are the best friends of the finance ministers, but that won’t last forever,” said Slovak central bank governor Peter Kazimir.