Editor’s Note: Otmar Issing, former chief economist and member of the board of directors of the European Central Bank, is chairman of the Center for Financial Studies at Goethe University in Frankfurt. The article reflects the views of the author and not necessarily those of CGTN.
After many years of low inflation, prices have risen everywhere in recent months. Energy and commodities led the way, mainly due to supply bottlenecks after the lockdown. But while such obstacles are widely seen as temporary, implying that the inflationary spike will soon disappear, other factors are also at work, implying that they will not.
The main of these long-term factors is the rapid growth of the currency. Most monetary aggregates (not just central bank money) have grown at breakneck speed, although this development does not seem to worry central banks and many economists. As money has disappeared from the main models used to explain inflation, the famous saying of the Nobel laureate economist Milton Friedman that “inflation is always and everywhere a monetary phenomenon” is rarely cited.
The “quantity theory” claims that the causality of inflation runs from money to prices. Yes, the empirical evidence seems to have largely undermined Friedman’s hypothesis regarding moderate inflation. But the fact remains that nominal wages and the prices of goods and services cannot continue to rise without a corresponding expansion of the currency. And strong money growth over time can also increase the risks of asset prices and financial stability.
After more than a decade in which various factors – globalization and demographic change, to name just two – have exerted downward pressure on prices, the world may now be on the cusp of broader economic “regime change”. Rising healthcare spending in aging societies, the slowing pace of globalization, supply chain disruptions and recent calls to relocate production to high-cost regions represent new sources of exogenous pressure on prices. Under these conditions, wages could also be pushed up.
At a time when central banks are almost yearning for somewhat higher inflation and ignoring rapid currency growth, such a shift in the real sector is likely to indicate a shift from a deflationary to an inflationary environment. Many of the factors seen today were prominent features of the 1960s and 1970s, the last time inflationary pressures built up.
Should we expect the return of stagflation? It’s hard to say, because we are experiencing an unusually high degree of the kind of unquantifiable uncertainty that economist Frank Knight has argued is impossible to fit into traditional forecasting. In addition to the dramatic structural changes that the global economy has undergone in recent years, the pandemic may have created the conditions for consequences that we cannot currently foresee.
The European Central Bank tower in Frankfurt, Germany. / Getty
The European Central Bank tower in Frankfurt, Germany. / Getty
Worse, central banks seem to rely heavily on models that lost much of their forecasting capacity years ago, due to their lack of viable theoretical explanations for what determines financial flows, premiums risk and asset prices. More than a decade after the 2008 financial crisis, the main general equilibrium models used by central banks barely take into account the great heterogeneity of households in terms of wealth, long-term debt outstanding, and risks. uninsured and anticipation training. As such, they are not equipped to grasp the complex effects that systematic policies or systemic shocks have on the distribution of wealth and inequality, and therefore on aggregate demand.
Without this knowledge, one can only guess whether strong monetary growth reflects precautionary savings due to rising inequalities, an inflationary fiscal-monetary shock, or both. This is particularly problematic in a world where central banks are massively expanding the monetary base by buying assets at high prices from a small group of relatively wealthy and informed investors.
Expectations play a key role in forecasting future inflation, and these appear to be firmly anchored at low levels. But what if these expectations, after so many years of very low inflation, were now more retrospective than prospective? With the fear of inflation gone from most radar screens, it is perhaps understandable that the recent price hikes are seen as purely temporary. But, since monetary policies tend to have a long and variable time lag, it is risky to wait until the rise in inflation has already taken hold before starting to gradually reduce quantitative easing or raise interest rates. ‘interest.
After all, what credibility will central banks have if inflation expectations have already lost their anchor? In an environment of extreme uncertainty, betting so much on the longer-term stability of inflation expectations is a risky bet. In times of regime change, uncertainty is so high that it is simply impossible to form rational expectations.
In addition to strong money growth, today’s extraordinarily high levels of private and public debt pose another incalculable risk. The sustainability of public finances in highly indebted countries rests on fragile ground and is highly exposed to shocks that can come from numerous economic or geopolitical sources.
I am not predicting the inevitable return of high inflation. But I am worried about strong monetary growth and its determinants, starting with the massive purchases of government securities by central banks. Central banks seem far too optimistic about this risk. They are also ignoring the heightened uncertainty of the current environment, including by issuing forward guidance that promises a fairly long continuation of extremely low policy rates and high asset purchases.
In the case of the euro zone, it is revealing that some observers are starting to predict not inflation but a kind of Japanification: low inflation and nominal interest rates, high public deficits and growing fiscal and financial domination. However, given the increase in wealth inequalities and the likelihood that financial investors will end up losing confidence in the sustainability of public finances, it is not certain that such conditions are politically sustainable. The only certainty is that neither a financial collapse nor an inflationary surge can be ruled out.
Copyright: Project union, 2021.
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