If suffering through a pandemic weren’t bad enough, a growing chorus of voices is warning us to beware inflation too.
In recent days, analysts at RBC Capital Markets, J.P. Morgan and Research Affiliates have warned customers that inflation could jump – not immediately, to be sure, but soon.
Meanwhile, gold prices have climbed in recent weeks on growing fears that the current crisis will end in some sort of inflationary blowup. Gold promoters are busily telling tales of the currency debasement to come.
Should you be concerned? Despite the current obsession over the issue, probably not. For all the fuss and fury, surging inflation remains a minor possibility, if that.
Just ask the bond market. With long-term government bond rates for most advanced countries near historic lows, the fixed-income market is signalling it sees no hint of resurgent inflation ahead. Consider the large institutions that are buying the 30-year Government of Canada bond at its current measly yield of less than 1.2 per cent a year. They are essentially betting that inflation will remain dormant over the next three decades.
What makes the current fear of rising inflation particularly odd is that price levels are tumbling in most developed countries as a result of rising joblessness and imploding demand. In Canada, the annualized inflation rate sank to a mere 0.9 per cent in March, its lowest level since 2015.
But today’s fading prices don’t deter the inflation lobby. They focus on the possibility that governments will decide to inflate away the debt they are now running up to help fight the novel coronavirus.
The inflation fear mongers also raise the possibility that companies in advanced economies could decide to de-globalize and bring key factories and suppliers closer to home. If so, the argument goes, domestic pricing pressures would become a lot more important, since companies could no longer keep a lid on costs by offshoring production to cheaper overseas suppliers.
Taken together, the warnings of these prognosticators make it sound as if we’re walking through an inflationary minefield. For a more balanced viewpoint, though, you should turn to Olivier Blanchard, one of the world’s most distinguished macroeconomists.
In a recent post for the Peterson Institute for International Economics, he concedes that an outburst of inflation in advanced economies is possible. But it is, he says, highly unlikely.
One reason is that demand for products and services is likely to stay depressed for a long time after the pandemic is past. Many households will be struggling to rebuild their ravaged savings and won’t be spending as much as they once did. Meanwhile, businesses have little reason to invest in new stores or factories since no rebuilding is necessary.
Three ingredients would have to combine before inflation would rip, according to Mr. Blanchard, a former chief economist at the International Monetary Fund and a professor emeritus at the Massachusetts Institute of Technology.
The first necessity would be an absolutely enormous run-up in the ratio of government debt to gross domestic product (GDP) – something much larger than is now assumed in various stimulus programs.
This would have to be combined with strong upward pressure on interest rates. This combination of more debt and higher interest rates would swell government’s debt payments and increase the appeal of letting inflation creep upward.
But even that wouldn’t be enough to set off an inflationary surge if central banks continued to stand strong against price pressures.
To truly spark inflation, what is required is a government that would impose its will on the central bank and force it to keep interest rates unnaturally low, so as to reduce the burden of servicing the government’s accumulated debt.
If all these factors were to combine, inflation could jump, Mr. Blanchard acknowledges. But he points out, each of the three factors is unlikely in itself. The combination of the three is unlikelier still.
Governments would have to assume much larger amounts of debt than currently contemplated. Meanwhile, interest rates would have to suddenly reverse their three-decade decline and start to rise. Most important of all, central banks would have to throw away their inflation-fighting credentials – something that policy makers have spent decades establishing.
“I asked some of my colleagues for their probabilities [of all three events occurring], and this product always came below 3 per cent,” he writes.
Anyone betting on inflation to roar back in coming years should keep that math in mind. By all means, it is worth keeping some inflation protection in your portfolio – but not nearly as much as the fear mongers would suggest.
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