High inflation is probably transitory, and central banks should tell people that… but totally be ready in case they aren’t. That’s the take from the IMF today, who released its latest global outlook. The agency said high inflation should ease, and central banks should communicate that message. However, it may not be transitory, and monetary authorities should be ready to act if it’s not.
The Pandemic Provided The Perfect Environment For High Inflation To Soar
This isn’t groundbreaking for anyone that’s had to buy anything recently, but the price of goods is climbing. A lot. The pandemic provided a perfect combination of restricted supply, and stimulus for demand. Supply restrictions came in the form of reduced production to accommodate health measures. Tight transport also made shipping goods cost-prohibitive.
Stimulus demand largely came in the form of low interest rates, and the wealth effect. Low interest rates cause budgets to rapidly expand, helping to provide cheap capital. When the price of assets rises, people engage in a “wealth effect.” This means they spend more because they feel rich.
The combination has pushed global inflation readings higher. Canada’s consumer price index (CPI) is currently reading 3.6% higher than a year before. US CPI came in even higher, showing annual growth of 5.4% at the last measure. This is the highest rate both countries have experienced in a very long time. Naturally, people are starting to worry about how high this can get over the next few years.
High Inflation Is Expected To Be “Transitory,” aka Temporary
The official take is that inflation expectations are just a transitory issue. Prices should come back down to reality over the next few months. “Inflation is expected to return to its pre-pandemic ranges in most countries in 2022 once these disturbances work their way through prices, though uncertainty remains high,” said the IMF
As the economy reopens and the effect of low interest rates wears thin, prices should pull back. We’ve begun to see some signs of that, with lumber as a good example. Prices surged 10x its pre-pandemic price, but have since fallen over 60% lower from their peak. And that’s the problem in a nutshell. Both takes are correct. High inflation is proving to be transitory, but is significantly higher than normal. After all, a 60% drop after a 10x increase is still a lot higher than it started.
IMF Warns Central Banks To Be Prepared If Inflation Isn’t Transitory
The IMF warned central banks not to act too hastily, and wait for more clarity. “Central banks should generally look through transitory inflation pressures and avoid tightening until there is more clarity on underlying price dynamics,” said the agency.
In the meantime, they suggest central banks communicate the expectations of high inflation. Higher inflation expectations tend to play a role in shaping future expectations.
“Clear communication from central banks on the outlook for monetary policy will be key to shaping inflation expectations and safeguarding against premature tightening of financial stimulus conditions.”
They do, however, warn central banks to be on high alert these days. In the event inflation doesn’t taper as expected, central banks need to be able to stop stimulus. This could include ending quantitative ease (QE) programs, as New Zealand recently did. In a more extreme situation it could mean hiking the overnight rate and reducing liquidity.
“There is, however, a risk that transitory pressures could become more persistent and central banks may need to take preemptive action,” said the agency.
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I wonder if they said inflation was transitory in the 1970s right to the double digit crushing numbers right through the 1980s.
Every monetary innovation they have to lose control of inflation. In the 70s it was the detaching from hard money (gold), which allowed foreign buyers to scoop everything in sight with more stable currencies. In the 2020s, it’ll be because they tried to embrace MMT.
MMT is like socialism. It works if everyone wants the same thing. IF they don’t it really screws up everything. The constant low interest rate environment forces the flight to alternative assets.
MMT is a theory that hasn’t been properly tested in real time. It flouts the wisdom of the ages which states that playing with debt is like playing with fire. Fire & combustion are useful but deserve a healthy respect and careful caution. MMT throws caution to the wind by printing tons of money (QE) to free up huge liquidity (debt) to fuel government spending and economic activity.
Basically, in Canada the Liberals and BOC have put us in a place where we’ve gone so far and we might as well engage in full MMT….there’s no going back now……
MMT is not prescriptive, and it does not *recommend* money creation.
Modern Monetary Theory is simply a different way of describing how money works, as compared to the current neoclassical paradigm in which banks, money and debt do not exist. Friedman’s monetarism, where tried, failed miserably, because it is divorced from reality.
MMT argues that in our economy, most money is created in the act of lending by banks, when they extend credit in the form or a mortgage. When the money is paid back the principal is “destroyed”
Central banks are supposed to be independent from elected governments. They fight fiercely to keep that independence, but the reality is that they are entirely captured by the financial industry.
The development of “QE” means that central banks are taking on a fiscal role, which consists of making sure that investors don’t lose money on their failed investments, giving them freshly minted cash in exchange for assets that aren’t paying off.
This is not the free market – one commentator called it “financial communism”.
Your second last paragraph is telling. What are the possible outcomes?
How many times did they change the basket of goods in the 70s and 80s? I’m guessing they’ve never done it in the middle of an inflation crisis before. We didn’t just straight-up lie to people as often back in the day.
Yes they did.
Inflation started to become a problem in the mid-60s. Then in 1970 there was a recession, and inflation dropped to almost nothing, and economists all said “See? We told you it was temporary.” In 1971-72, the inflation rate took off in the recovery, and never looked back. And don’t let anyone tell you that was because of the oil crisis. The oil crisis didn’t happen until autumn 1973. Inflation was running well above 5% for at least a year before the oil crisis even happened. The oil shocks of 1973 and 1979 were definitely aggravating factors, but they occurred in an already inflationary environment.
TLDR: Yes. They did dismiss it as temporary back then.
They almost always cut too soon, and hike too late. Be ready to hike is their way of telling people they’ll have to hike faster than they led everyone to believe.
As if they’ll ever actually give you the real inflation numbers.
Exactly. Central banks have lost the trust of the people. They just lied too much and too often. Hence the flight to digital currency.
It’s nice to see every country in the world is having the same inflation issues.
Every central bank is now interdependent on each other, while the kingpins demand countries can’t be too competitive or else. i.e. the minimum tax rules for companies. Every advanced economy has to have a minimum tax, unless it’s a financial firm. It doesn’t matter if they need it? Bollocks. Give me a break.
I disagree.
You should be prepared to act swiftly based on the knowledge that the central bank will not raise rates to combat inflation.
It will be interesting to see if Tiff ends up a hero or a zero……
To be honest, I’m not sure what to make of this editorial. I have to assume he is being honest……
https://financialpost.com/news/economy/tiff-macklem-the-bank-of-canada-remains-firmly-committed-to-keeping-inflation-under-control