Just a small probability of high inflation
Olivier Blanchard argues that three factors need to be in place for the scenario of high inflation to materialize:
- First is a very large increase in the debt-to-GDP ratio, larger than the 20 to 30 percent or so under current forecasts – under the assumption of more waves of COVID, the precarious state of many households and firms will require more and more fiscal spending for disaster relief for each successive wave.
- Second is a very large increase in the neutral rate of interest – an increase in the ratio of debt to GDP of 60 percent, might lead to an increase in the neutral rate of 120 to 240 basis points, an increase that would get the neutral rate close to or above the growth rate;
- Third, and perhaps most important, is fiscal dominance of monetary policy – as the government might be tempted to ask the Fed to keep the interest rate low, so as to decrease the debt burden.
High inflation is unlikely but not impossible in advanced economies
By: Olivier Blanchard – Peterson Institute for International Economics
Inflation expectations might de-anchor
Dietrich and al. surveyed households about their expectations of the economic fallout of the COVID-19 pandemic, in real time and at daily frequency for the entire month of March. Their baseline question asks about the expected impact on output and inflation over a one-year horizon:
- The median response suggests that respondents expect the shock to raise inflation by about 5 percentage points;
- At the end of March the median response regarding the expected output loss amounts to 15%.
News and Uncertainty about COVID-19: Survey Evidence and Short-Run Economic Impact
Authors: Alexander M. Dietrich, Keith Kuester, Gernot J. Müller, Raphael S. Schoenle
From: University of Tübingen, University of Bonn, Brandeis University
The bleaker view
Inflation will rise considerably above the level of nominal interest rates that our political masters can tolerate. The excessive debt amongst non-financial corporates and governments will get inflated away. The negative real interest rates that may well be necessary to equilibrate the system, as real growth slows in the face of a reversal of globalisation and falling working populations, will happen. Even if central banks feel uncomfortable with such higher inflation, they will be aware that the continuing high levels of debt make our economies still very fragile. And if they try to raise interest rates in such a context, they will face political ire to a point that might threaten their ‘independence’. Only when indebtedness has been restored to viable levels can an assault on inflation be mounted.
Future imperfect after coronavirus
By: Charles Goodhart, Manoj Pradhan – LSE, Talking Heads Macroeconomics
