Low inflation underpins today’s economic policy. It is not guaranteed to last
Economists love to disagree, but almost all of them will tell you that inflation is dead. The premise of low inflation is baked into economic policies and financial markets. It is why central banks can cut interest rates to around zero and buy up mountains of government bonds. It explains how governments have been able to go on an epic spending and borrowing binge in order to save the economy from the ravages of the pandemic—and why rich-world public debt of 125% of gdp barely raises an eyebrow. The search for yield has propelled the s&p 500 index of shares to new highs even as the number of Americans in hospital with covid-19 has surpassed 100,000. The only way to justify such a blistering-hot stockmarket is if you expect a strong but inflationless economic rebound in 2021 and beyond.
Yet as we explain this week (see article), an increasingly vocal band of dissenters thinks that the world could emerge from the pandemic into an era of higher inflation. Their arguments are hardly overwhelming, but neither are they empty. Even a small probability of having to deal with a surge in inflation is worrying, because the stock of debt is so large and central-bank balance-sheets are swollen. Rather than ignore the risk, governments should take action now to insure themselves against it.
In the decades since Margaret Thatcher warned of a vicious cycle of prices and wages that threatened to “destroy” society, the rich world has come to take low inflation for granted. Before the pandemic even an ultra-tight jobs market could not jolt prices upwards, and now armies of people are unemployed. Many economists think the West, and especially the euro zone, is heading the way of Japan, which fell into deflation in the 1990s and has since struggled to lift price rises far above zero.