Deutsche Bank economists say "this time is different for inflation" and policy makers could be facing their most challenging time in about 40 years.
In a new report titled: What's in the tails? - Inflation: The defining macro story of this decade the bank's senior economists note the globally receding fear of inflation and rising levels of government debt that shaped a generation of policymakers.
"Replacing it is the perspective that economic policy should now prioritise broader social goals," say the bank's chief economist David Folkerts-Landau, global head of economic research Peter Hooper and head of thematic research Jim Reid.
Their report debates whether inflation is transitory or the pursuit of "these important social priorities by governments" will mean inflation will have longer-term and far reaching implications for the health of the global economy.
"Either way, higher inflation is coming and policymakers are about to face their toughest battle in 40 years," the economists say.
They say that two of the biggest historic constraints on macroeconomic policy – inflation and debt sustainability – are increasingly perceived as not binding. In turn, the removal of these constraints has opened the door for new goals for macro policy, which go far beyond simply stabilising output across the business cycle. This changing approach to macro policy has been formalised in the Federal Reserve’s operating procedures, making a broader interpretation of its mandate possible.
"Unlike in previous eras, when it was common practice to pre-empt inflation overshoots with higher rates, today’s Fed has said they want to see actual progress, not just forecast progress. The new average inflation targeting approach only increases tolerance for inflation.
"Where the US leads, others tend to follow. Even in Germany, with its reliable fiscal discipline, there is growing support for to reform the constitutional debt brake in order to permit more deficit spending. And although in aggregate the EU’s fiscal stimulus has been more limited than that seen in the US, the arrival of the €750bn Recovery Fund financed by collective borrowing potentially opens the way for further such packages in response to future crises. It is hard to see the ECB stepping back from helping to finance such fiscal investments in the continent or moves to promote further integration.
Fiscal injections 'off the charts'
"In short, we are witnessing the most important shift in global macro policy since the Reagan/Volcker axis 40 years ago. Fiscal injections are now 'off the charts' at the same time as the Fed’s modus operandi has shifted to tolerate higher inflation.
"Never before have we seen such coordinated expansionary fiscal and monetary policy. This will continue as output moves above potential.
"This is why this time is different for inflation."
The Deutsche economists says that even if some of the transitory inflation ebbs away, "we believe price growth will regain significant momentum as the economy overheats in 2022".
"Yet we worry that in its new inflation averaging framework, the Fed will be too slow to damp the rising inflation pressures effectively. The consequence of delay will be greater disruption of economic and financial activity than would be otherwise be the case when the Fed does finally act. In turn, this could create a significant recession and set off a chain of financial distress around the world, particularly in emerging markets.
No soft landings
"History is not on the side of the Fed. In recent memory, the central bank has not succeeded in achieving a soft landing when implementing a monetary tightening when inflation has been above 4%."
The economists say few people still remember "how our societies and economies were threatened" by high inflation 50 years ago.
They say the most basic laws of economics, the ones that have stood the test of time over a millennium, "have not been suspended".
"An explosive growth in debt financed largely by central banks is likely to lead to higher inflation," they say.
"We worry that the painful lessons of an inflationary past are being ignored by central bankers, either because they really believe that this time is different, or they have bought into a new paradigm that low interest rates are here to stay, or they are protecting their institutions by not trying to hold back a political steam roller.
"Whatever the reason, we expect inflationary pressures to re-emerge as the Fed continues with its policy of patience and its stated belief that current pressures are largely transitory.
"It may take a year longer until 2023 but inflation will re-emerge.
Scary thought...
"And while it is admirable that this patience is due to the fact that the Fed’s priorities are shifting towards social goals, neglecting inflation leaves global economies sitting on a time bomb.
"It is a scary thought that just as inflation is being deprioritised, fiscal and monetary policy is being coordinated in ways the world has never seen. Recent stimulus has been extraordinary and economic forecasting, which is difficult at the best of times, is becoming harder by the day. Fractured politics amplifies the problem. Needless to say, the range of global outcomes over the coming years is wide.
"When central banks are eventually forced to act on inflation, they will find it themselves in a difficult, if not untenable, position. They will be fighting the increasingly-ingrained perception that high levels of debt and higher inflation are a small price to pay for achieving progressive political, economic and social goals.
"That will make it politically difficult for societies to accept higher unemployment in the interest of fighting inflation.
"Eventually, though, any social priorities that policymakers have will be set aside if inflation returns in earnest. Rising prices will touch everyone. The effects could be devastating, particularly for the most vulnerable in society.
"Sadly, when central banks do act at this stage, they will be forced into abrupt policy change which will only make it harder for policymakers to achieve the social goals that our societies need. Low, stable inflation and historically low interest rates have been the glue that have held together macro policy for the last three decades. If, as we expect, this starts to unravel over the next year or two, then policymakers will face the most challenging years since the Volcker/Reagan period in the 1980s," the economists say.
43 Comments
Reserve banks have been shifting their goal post to suit their narrative. For how long can they manipulate and control by throwing money as sometime in future fundamentals have to catch up and their has to be a violent reaction and instead of delaying the inevitable should prepare themselves as up and DOWN is an economy cycle and is healthy in the long run.
Now if a small reaction, reserve bank comes out with more stimulus and this will continue as they themselves are responsible for being allowed to be blackmail by the market.
Earlier they understand that measures taken in emergency should be for emergency instead of making it a new norm.
https://www.cnbc.com/2021/06/07/deutsche-bank-warns-of-global-time-bomb…
Earlier they understand that measures taken in emergency should be for emergency instead of making it a new norm.
Too late for that. You could argue that Germany and Japan are an advantageous position in that they're net creditors to the world. Not so with the Anglosphere which prefers to live beyond its means. Despite the endless QE program in Japan, Japanese h'holds and firms have been paying down debt and not borrowing / spending like drunken sailors. I'm not saying that they're in a good position but I'm just highlighting the differences with say Are-oh-teer-ah-row-a.
Japan had its own asset bubble some years ago. Are they so different? https://en.wikipedia.org/wiki/Japanese_asset_price_bubble
For decades now these cretins in the reserve banks around the world have been throwing enormous and blatantly obviously unsustainable amounts of liquidity into their economys and the correlation to any benefit has been very tepid at best, with the, I presume unintended, major consequence being asset bubbles that lead to the next crisis. As I have said for years now the model that links CPI inflation to the official cash rate is severely flawed and while it may work when inflation is higher than the set point, the logic that it is appropriate for low inflation does not follow. The results speak for themselves.
To repeat the old saying, "the definition of insanity is to keep on doing the same thing and expect a different result." And they have been doing this now for over 20 years and still not changed their behavior.
Having stuck to this model when it has been patently not appropriate they surely cannot abandon it now that it is. I have a horrible feeling however that is exactly what they will do. The result will be out of control inflation and an immoral rewarding of the debt fueled speculators at the cost of the virtuous savers. This will further drive a huge wedge between the haves and the have nots. If they carry on at this rate you can expect significant upsets to world peace. e.g. the rise of Nazi style Trumpisim etc.
They fail to recognise the world is vastly different now. The race to the bottom Globalisation production and Internet Searching with quick price checking has structurally reduced inflation permanently. You've also got bucket loads of more debt globally which stops interest rates really rising up to a certain point before they destroy the economies they're trying to protect. The best way is too look through cost push inflation (as a lot of this is) and slowly return to normal interest rate settings.
Central bankers and policy makers should watch this video from the Bank of Jamaica every so often. Hopefully the tune will stay in their heads.
https://youtu.be/RuAwYsbUq48
I prefer the take from "Married with children"
https://www.youtube.com/watch?v=23jn0yAUkxk
One argument is that countries can just default on debt obligations if they are too onerous as long as it can run a balanced budget when required. Consequently forecasting inflation rates correctly is actually far more important to bond purchasers than countries. The place you get into trouble is if you cannot run a balanced budget when required because then the country becomes beholden to lenders. I think people forget that deleveraging works one of two ways, it's paid off or written off.
You can see this process at work in Argentina. Interestingly, despite the countries track record, they still seem to be relatively capable of accessing international finance.
Yes but I think some lenders are waking up to the fact that some countries are lost causes. Like most of Africa and Lebanon for example. Anywhere that corruption is rife simply means they are stealing your money with no intention of ever paying it back. I think the Chinese got a bit smarter, if you default they own your country.
Any increase in US rates will sweep the world faster than the Wuhan bio weapon has. Please remind me why is it a good time to pay historically crazy premium for assets that is not backed by returns, and then be stuck to the attached debt....?
Watching this space closely. Popcorn.
The reference to Larry Summers is unfortunate:
It’s the Economic foundation for what becomes Larry’s objection that is most objectionable. The Keynesian/Japanese idea of “too much.” The problem, as any mainstream Economist sees it, is that once you’ve filled in the trough you need to get out of the way of the recovery lest it run explosively hot seventies-style. Link
KW - I'm sure they are well aware; have been for some time. This time it is really different; this time it is concurrent and global. They staved off disaster in 2008, but could not fix the problem. Now, we are staring down the barrel. Keen talks of a debt forgiveness, I suspect a global Cyprus-like close/shave/open move is possible; the elite will try hard to keep both control and continuity.
But ultimately, Growth is stuffed. And with it, most of the bets laid upon its continuance. We've been watching the poor getting poorer (rent-transfer, cost-biases) for a long time, but it's been the middle class which has latterly been hollowed out. They don't know it yet, because they think their 60 year old house is somehow worth 2 mill next year, and they only owe 500k. When the dust settles on this bubble, that house will more likely be worth 150k; the question is whether they were foreclosed, or whether the system collapsed completely. We are so much more overdrawn than 2008, and so much less energised, that collapse is odds-on.
Nicole Foss used to argue we'll see rampant deflation; I see real resource scarcity driving initial inflation, which cannot be supported by the indebted. Then a falling-over. Greece tells us how quickly this can happen. Or Cuba. Whether we see deflation, I'm doubtful. Stagflation is more likely, if they somehow keep the ship afloat.....
PDK you include a comment here that i take issue with; "but could not fix the problem". The reality is they CHOSE to not fix the problem. In my comment below I mention the ceding of power to the private banks, and we tend to forget that in the US even the Fed is a private bank. For most if not all the world, Governments have ceded economic control to private banks. While they will argue that they still have control over policy, that control is largely toothless. This was demonstrated very well during the recent COVID crisis in NZ. Our finance minister Grant Robertson released money to the banks, with the very clear message that his intention was for it to be available to business's to sustain them during the crisis. Instead the banks put it out to continue the housing crisis. What did the Government do about that? Did they take those funds back, recall it? Did they call the banks to account? the answer to all those questions is a resounding NO! They did nothing, nada, not a thing. Why?
World wide there is a huge power imbalance, where very wealthy individuals, and institutions have largely become a power unto themselves. Governments struggle to be able to impose any significant level of regulation to ensure benefits are even spread across society. You talk about the end of easy resources and the impacts on the environment, but these institutions and people act as though somehow they will be immune. And in reality they often are. In the Christchurch earthquake, insurance companies who had profited for years, taking premiums which included a component to cover for the 1:1000 year event, suddenly found themselves without the reserves or cover to cover what they had insured, and what did the government do? Instead of holding those companies to account, they set up their own recovery organisation. In other words they effectively bailed out the insurance companies, as regulations governing them still do not hold them to account on what reserves they need to have to ensure that can cover all that they have insured on their books.
And worse, many of the banks, that economies are so reliant on, are private institutions, beholden to no one bar their shareholders. And worse, Governments have systematically ceded a lot of their financial control to those banks. In other words, governments need to take control back, but to do so will be seen as a threat to many of the major shareholders and owners of those banks. So the question is, who has the bigger balls?
Politicians, generally lust after power and influence. Mega wealthy bank owners have power and influence backed up with an awful lot of money. What will be the outcome of that battle?
From the former Morgan Stanley economist Andy Xie
https://www.scmp.com/comment/opinion/article/3133876/inflation-coming-a…
What inflation? $10 dollar Tauranga house prices now over a million. Jacinda you have to hand your notice in for the good of NZ. Please. https://www.sunlive.co.nz/news/270148-tauranga-house-prices-break-1m-ba…
I live in Tauranga mate and that's a bit insulting, call it what it really is, its $20 Tauranga now. Most jobs down here pay $20 to $25 an hour and your really lucky to be on $35 an hour, still I didn't come down here to work, you come down here NOT to work and to escape the shit hole Auckland has turned into. Yep my house just cracked the million, up $200K in 9 months. Thought it would take till Christmas but Christmas came early this year thanks to Jacinda pulling out all the stops for me. Think I'm going to send her a card this year.
Deutsche Bank has some of the world's best economists working there who are not encumbered by their employers in their communication. However, it is evident that Angela Merkel doesn't buy theirs, neither does Euro Bank.
What makes people think that the Fed will buy it?
Another day, another inflation scare story. What we are seeing is inflation in some product categories, which is a direct response to supply chain issues and surges in demand following the opening up of economies. If Govts insist on trying to buy more things that are in short supply (e.g. construction materials) then there is a risk of inflation on affected goods and services persisting for a while. However, *IF* the wages of a significant number of workers do not rise in response to temporary price increases, then inflation will fall back again overtime.
Also worth remembering that if people are paying more for a thing, then other people are being paid more for that thing. Inflation therefore redistributes money. The question to ask is whether the re-distributional impact of inflation in a given product areas is good or bad. For example, if inflation in construction materials or tradies drives new innovations in construction products, or leads to increases in apprenticeships, and this leads to reduced prices overtime, what's the problem? That's just the market doing it's job no?
I didn't say we did... But I do believe Govt needs to intervene at the macro level because a truly free market does *not* deliver the economists' wet dream of perfect prices, wholesome wages, full employment, and a healthy natural world (in fact it does quite the opposite).
Keynes got this spot on - he argued that Govermment should set rules and standards to ensure fair play and treatment of workers, provide a legal system to adjudicate, and intervene at the macro level to keep the economy working (e.g. boosting aggregate demand when the non-Govt sector is constrained for whatever reason). Keynes also argued that Government should NOT generally intervene at the micro (sector specific) level because the market was pretty good at adjusting for inflation in specific products and sectors.
Great article. It is not rocket science. NZ will be in more trouble than other countries because of its fake housing economy. NZ has a relatively high reliance on housing assets & has adopted a monetary policy which is far too expansive. NZ is likely to have a decade of serious pain as it has underestimated the impact that future inflation will have on correcting housing asset values.
Inflation requires availability of money plus demand exceeding supply, and this is evident in housing currently, so if central Banks increase interest rates discretionary income declines unless wages increase so demand outside of housing declines and the reduced economic activity costs jobs and taxes whilst benefits increase and Robbos current borrowing of approx $128 Million a day increases. Until demand abates or supply increases short term inflation does seem likely, however tapering of quantitative easing may not be far away . There are no good decisions available as the time to make them has passed so whatever decisions are made will produce pain and the best way to avoid the pain is to have no or low debt, cut living/operating costs sufficiently to at least be relatively better off than those who don't or cannot. Until I see the current collection of clowns who infest parliament impersonating a govt put real effort into reducing govt costs and rules that impede people/business from innovating and adapting the currently economic trajectory to doom will continue, and much of the world is doing the same.
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