Mar 1st 2021

Are Inflation Fears Justified? 

by Kenneth Rogoff

Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University, and was formerly chief economist at the IMF.

 

CAMBRIDGE – Massive fiscal and monetary stimulus programs in the United States and other advanced economies are fueling a raging debate about whether higher inflation could be just around the corner. Ten-year US Treasury yields and mortgage rates are already climbing in anticipation that the US Federal Reserve – the de facto global central bank – will be forced to hike rates, potentially bursting asset-price bubbles around the world. But while markets are probably overstating short-term inflation risks for 2021, they do not yet fully appreciate the longer-term dangers.

To be clear, huge macroeconomic support is unequivocally needed now and for the foreseeable future. The pandemic-induced recession is worse than the 2008 global financial crisis, and parts of the US economy are still in desperate straits. Moreover, despite promising vaccine-related developments in the fight against the coronavirus, things could get worse.

Against this backdrop, the real inflation risk could materialize if both central-bank independence and globalization fall out of favor. In the near term, policymakers are right to worry that, if the economy continues to heal, stimulus measures and consumers’ cash savings will fuel an explosion in demand. But this is unlikely to lead to an overnight inflation blowout, mainly because price growth in modern advanced economies is a very slow-moving variable. Even when inflation reached double digits in many rich countries in the 1970s (and rose above 20% in the United Kingdom and Japan), it took many years to collect a full head of steam.

This is mainly because the speed at which prices and wages rise is acutely sensitive to how workers and firms view the economy’s underlying inflation dynamic. That is, today’s inflation is very much influenced by long-term inflation expectations.

That reasoning may seem circular, but it reflects the fact that, in many sectors, firms are reluctant to raise prices too aggressively for fear of losing market share. So, if central banks can succeed in “anchoring” long-term inflation expectations at a low rate, they can put the brakes on any prolonged inflation outburst. And today, years of ultra-low inflation are firmly embedded in the public psyche.

All this implies that even with rapid economic normalization, pent-up demand and large fiscal stimulus will not trigger an immediate spike in inflation. But if politicians undermine central-bank independence and prevent a timely normalization of policy interest rates, even deeply ingrained low-inflation expectations could fray.

The other long-term inflation risk is subtler, but potentially even harder to forestall. Many people are vastly more skeptical about globalization today than they were three decades ago, largely because evidence suggests that the wealthy have benefited disproportionately from it. While stock markets have soared, labor has been receiving a declining share of the economic pie. And many of the proposed measures that might enable workers to claw back a bigger cut, such as boosting unionization and making offshoring more difficult, will necessarily mean a reduction in trade.

A reversal of globalization could have a big impact on inflation. Many Westerners fear that China will “eat our lunch,” as US President Joe Biden recently warned in calling for a much-needed increase in infrastructure investment in America. Maybe, but Westerners need to recognize that when it comes to global manufacturing, China is the one making lunch, and the meal would cost a lot more if it wasn’t.

More broadly, central banks’ disinflation efforts from 1980 until the 2008 financial crisis benefited enormously from the hyper-globalization taking place during this period. Trade with China and other developing countries, combined with technological advances, relentlessly drove down the prices of many consumer goods.

With productivity rising and many prices visibly falling, for reasons beyond monetary policy, it became relatively easy for central bankers to move the public’s long-term inflation expectations downward. But when I pointed this out at a major conference of central bankers back in 2003, in a paper entitled “Globalization and Global Disinflation,” most of them did not really want to share credit with globalization.

Things could now move in the other direction, especially given the strong bipartisan political consensus in Washington on the need to challenge China. The substance of Biden’s policies may not differ from those pursued by former President Donald Trump as quickly or as radically as many internationalists might hope. And even if the US and China manage to patch over their current differences, globalization’s impact is set to fade, owing in part to demographic factors, as Charles Goodhart and Manoj Pradhan have forcefully argued. China’s labor force, for example, is projected to shrink by 200 million over the next two decades.

So, should markets be panicking about a possible spike in demand driving up inflation and interest rates, causing asset prices to fall across the board? In the near term, not so much. It is even possible that a year from now, central banks will be seriously considering deeply negative interest rates in order to rekindle inflation and demand. And it would not necessarily be a bad thing if inflation were to rise above target for a couple of years after being so low for so long. But longer-term inflation risks are skewed much more to the upside than markets or policymakers seem to realize.


Kenneth Rogoff, a former chief economist of the International Monetary Fund, is Professor of Economics and Public Policy at Harvard University. 

Copyright: Project Syndicate, 2021.
www.project-syndicate.org
 

 


This article is brought to you by Project Syndicate that is a not for profit organization.

Project Syndicate brings original, engaging, and thought-provoking commentaries by esteemed leaders and thinkers from around the world to readers everywhere. By offering incisive perspectives on our changing world from those who are shaping its economics, politics, science, and culture, Project Syndicate has created an unrivalled venue for informed public debate. Please see: www.project-syndicate.org.

Should you want to support Project Syndicate you can do it by using the PayPal icon below. Your donation is paid to Project Syndicate in full after PayPal has deducted its transaction fee. Facts & Arts neither receives information about your donation nor a commission.

 

 

Browse articles by author

More Current Affairs

May 31st 2023
EXTRACT: "In discussions about the implications of artificial intelligence (AI), someone almost always evokes the ancient Greek myth of Pandora’s box. In the modern fairytale version of the story, Pandora is depicted as a tragically curious young woman who opens a sealed urn and inadvertently releases eternal misery on humankind. Like the genie that has escaped the bottle, the horse that has fled the barn, and the train that has left the station, the myth has become a cliché. And yet the actual story of Pandora is far more apropos to debates about AI and machine learning than many realize. What it shows is that it is better to listen to “Prometheans” who are concerned about humanity’s future than “Epimetheans” who are easily dazzled by the prospect of short-term gains. One of the oldest Greek myths, the story of Pandora was first recorded more than 2,500 years ago, in the time of Homer. In the original telling, Pandora was not some innocent girl who succumbed to the temptation to open a forbidden jar. Rather, as the poet Hesiod tells us, Pandora was “made, not born.” Having been commissioned by all-powerful Zeus and designed to his cruel specifications by Hephaestus, the god of invention, Pandora was a lifelike android created to look like a bewitching maiden. Her purpose was to entrap mortals as a manifestation of kalos kakon: “evil hidden in beauty.”
May 31st 2023
EXTRACT: "Specifically, many believe that the arrival of artificial general intelligence (AGI) – an AI that can teach itself to perform any cognitive task that humans can do – will pose an existential threat to humanity. A carelessly designed AGI (or one governed by unknown “black box” processes) could carry out its tasks in ways that compromise fundamental elements of our humanity. After that, what it means to be human could come to be mediated by AGI."
May 29th 2023
EXTRACT: "In his 2018 book Destined For War, political scientist Graham Allison observes that the US and China are headed toward what he called the “Thucydides’ Trap,” a reference to the ancient Greek historian’s account of Sparta’s efforts to suppress the rise of Athens, which ultimately culminated in the Peloponnesian War. A better analogy, however, is the message sent by the Athenians to the inhabitants of the besieged island of Melos before executing the men and enslaving the women and children: “The strong do what they can and the weak suffer what they must." ---- Allowing China and other authoritarian countries to shape the rules would result in a world order based solely on this “realist” principle. It is a nightmare scenario that the G7 countries and other liberal democracies must strive to prevent. ---- China’s assertions about the decline of the West reveal an underlying anxiety. After all, if liberal democracy is failing, why do Chinese officials consistently express their fear of it? The fact that leaders of the Communist Party of China have instructed rank-and-file members to engage in an “intense struggle” against liberal-democratic values indicates that they view open societies as an existential threat."
May 28th 2023
EXTRACTS: "Cyberspace Administration of China (CAC) decreed that generative AI content must “embody core socialist values and must not contain any content that subverts state power, advocates the overthrow of the socialist system, incites splitting the country or undermines national unity.' ” .... "This implies that the harder the CAC tries to control ChatGPT content, the smaller the resulting output of chatbot-generated Chinese intelligence will be – yet another constraint on the AI intellectual revolution in China. Unsurprisingly, the early returns on China’s generative-AI efforts have been disappointing."
May 20th 2023
EXTRACTS: "Cognitive dissonance occurs when one’s beliefs and actions conflict with each other." .... "This conflict might constrain people from acquiring new information that will increase the existing dissonance" .... "if someone commits wholeheartedly to Trump, they may well experience dissonance as they watch the news from that Manhattan courthouse. But they don’t necessarily stop supporting him. Instead, they might seek yet more information about the “deep state” and how it is persecuting Trump, or preach more about his positive attributes and the witch hunt against him." .... " If so, we can expect to see more conspiracy theories and more proselytising from the hardcore supporters going into 2024 and beyond. Donald Trump may not be finished just yet."
May 11th 2023
EXTRACT: "....the US possesses advantages in developing large language models (LLMs). It benefits from close business-university collaboration, lubricated by a deep-pocketed venture-capital industry. It is no coincidence that ChatGPT came out of the US, and out of Greater Silicon Valley in particular." .... "Developing countries would seem to be at a significant disadvantage in this AI arms race and are at risk of losing their competitive advantage: abundant low-cost labor. Yet AI also holds out the promise of benefits for these countries." .... " however, economic development depends on human development – that is, on the accumulation of human capital. Where developing countries lack the resources, financial and otherwise, to increase significantly their spending on traditional modes of education, AI holds out hope for providing what is missing."
May 2nd 2023
EXTRACT: "The past decade has not been kind to neoliberalism. With 40 years of deregulation, financialization, and globalization having failed to deliver prosperity for anyone but the rich, the United States and other Western liberal democracies have seemingly moved on from the neoliberal experiment and re-embraced industrial policy. But the economic paradigm that underpinned Thatcherism, Reaganomics, and the Washington Consensus is alive and well in at least one place: the pages of the Economist."
Apr 25th 2023
EXTRACT: "Yet there is an important twist for the US: a chronic shortfall of domestic saving casts the economic consequences of conflict with China in a very different light. In 2022, net US saving – the depreciation-adjusted saving of households, businesses, and the government sector – fell to just 1.6% of national income, far below the longer-term 5.8% average from 1960 to 2020. Lacking in saving and wanting to invest and grow, the US takes full advantage of the dollar’s “exorbitant privilege” as the world’s dominant reserve currency and freely imports surplus saving from abroad, running a massive current-account and multilateral trade deficit to attract foreign capital."
Mar 31st 2023
EXTRACT: "Although the EU will have gained more internal stability, its basic character will have changed. Security will be a central concern for the foreseeable future. The EU will have to start thinking of itself as a geopolitical power and as a defense community working closely with NATO. Its identity will no longer be defined mainly by its economic community, its common market, or its customs union. The bloc has already accepted Ukraine as a candidate for future membership, and that decision was driven almost entirely by geopolitical considerations (as was also the case, previously, with Turkey and the West Balkan states)."
Mar 30th 2023
EXTRACT: "As I have long warned, central banks ..... will likely wimp out (by curtailing monetary-policy normalization) to avoid a self-reinforcing economic and financial meltdown, .... "
Mar 30th 2023
EXTRACT: "Netanyahu is simply unfit to be prime minister of Israel. He is a liar, a schemer and a fraud. If he has an ounce of integrity left in him, he should resign and save the country instead of stopping short of nothing, however evil, to save his skin."
Mar 29th 2023
EXTRACTS: "Though Mao Zedong viewed himself as Joseph Stalin’s peer, leading the world’s peasant communists as Stalin led its proletarians, behind closed doors Stalin reportedly called Mao a “caveman Marxist” and a “talentless partisan.” " ----- "Stalin’s behavior enraged Mao." ---- "When ..... Khrushchev, took over as Soviet premier following Stalin’s death in 1953, Mao paid back for Stalin’s disdain – and then some. On his return from his trip to Beijing in 1958, Khrushchev talked incessantly about how unpleasant his experience had been." ---- "Even if Xi did not have the upper hand before Russian President Vladimir Putin launched his war of choice in Ukraine, he certainly has it now..." --- "So, when Xi arrived in Moscow ..... he carried himself with an air of superiority, whereas Putin’s expressions appeared strained."
Mar 27th 2023
EXTRACT: "The spectacular collapse of Silicon Valley Bank (SVB) – the second-largest bank failure in US history – has evoked memories of the 2008 collapse of Lehman Brothers, which sparked the worst economic crisis since the Great Depression. But the current situation is, at least for Germans and other Europeans, more reminiscent of the “founder’s crash” (Gründerkrach) of 1873. Then, as now, an era of cheap credit had fueled a tech boom and then triggered a banking crisis. In those days, the startups were in railroads, electronics, and chemistry, but there were also a large number of financial startups rising with the tide. In both cases, the crisis was rooted in bad accounting rules that turned the financial system into a playground for gamblers."
Mar 16th 2023
EXTRACT: "Putin is desperate for a ceasefire, but he does not want to admit it. Chinese President Xi Jinping is in the same boat. But US President Joe Biden is unlikely to jump at this seeming opportunity to negotiate a ceasefire, because he has pledged that the US will not negotiate behind Zelensky’s back. -- The countries of the former Soviet empire, eager to assert their independence, can hardly wait for the Russian army to be crushed in Ukraine. At that point, Putin’s dream of a renewed Russian empire will disintegrate and cease to pose a threat to Europe. -- The defeat of Russian imperialism will have far-reaching consequences for the rest of the world. It will bring huge relief to open societies and create tremendous problems for closed ones."
Mar 15th 2023
EXTRACT: "Fifty years ago, a war broke out in the Middle East which resulted in a global oil embargo.... " ---- " Many historical accounts suggest the decade of global inflation and recession that characterises the 1970s stemmed from this “oil shock”. But this narrative is misleading – and half a century later, in the midst of strikingly similar global conditions, needs revisiting." ----- "In early 2023, the global financial picture feels disconcertingly similar to 50 years ago. Inflation and the cost of living have both risen steeply, and a war and related energy supply problems have been widely labelled as a key reason for this pain." ---- "In their public statements, central bank leaders have blamed this on a long (and movable) list of factors – most prominently, Vladimir Putin’s decision to send Russian troops to fight against Ukrainian armed forces. Anything, indeed, but central bank policy." ---- "Yet as Figure 1 shows, inflation had already been increasing in the US and Europe long before Putin gave the order to move his troops across the border – indeed, as far back as 2020."
Mar 7th 2023
EXTRACT: "The United States is in the midst of a book-banning frenzy. According to PEN America, 1,648 books were prohibited in public schools across the country between July 2021 and June 2022. That number is expected to increase this year as conservative politicians and organizations step up efforts to censor works dealing with sexual and racial identity."
Feb 28th 2023
EXTRACT: "As was the case before World War I, it is tempting to minimize the risk of a major conflict. After all, today’s globalized, interconnected world has too much at stake to risk a seismic unraveling. That argument is painfully familiar. It is the same one made in the early twentieth century, when the first wave of globalization was at its peak. It seemed compelling to many right up to June 28, 1914."
Feb 19th 2023
EXTRACT: "Another front has opened in the global rise of populist authoritarianism. With their efforts to weaken Israel’s independent judiciary, Prime Minister Binyamin Netanyahu and his corrupt coalition of Messianic fascists and ultra-Orthodox allies are determined to translate their anti-democratic rhetoric into authoritarian policy."
Feb 17th 2023
EXTRACT: "One year on from the start of a military operation that Moscow was expected to win easily, there are increasing signs of anger, frustration and resistance from ordinary Russian soldiers. These are important reminders that these men are not mindless pawns who will do Putin’s bidding under any circumstances."
Feb 16th 2023
EXTRACT: "Over the past few days, more details have emerged about the alleged Russian plot in Moldova. Apparently, well-trained and well-equipped foreign agents were meant to infiltrate the ongoing protests, then instigate and carry out violent attacks against state institutions, take hostages and replace the current government. This may seem far-fetched, but is it? Yesterday, Moldova denied entry to Serbian soccer fans who had planned to support their team, FK Partizan Belgrade, in a Europa Conference League match against the Transnistrian side Sheriff Tiraspol. ---- " ..... there is a history of Serbian football hooligans being involved in paramilitary activities, including war crimes committed by the notorious Arkan Tigers during the war in Bosnia in the early 1990s. Moreover, Russia attempted to overthrow the Montenegrin government in October 2016, just ahead of the country’s Nato accession the following year, in a plot eerily prescient of what was allegedly planned recently in Moldova.