Inflation may be order of the day after covid crisis

Central banks and governments in the West are trying to prevent deflation in the post-covid world. What if inflation and not deflation becomes the order of the day?

Vivek Kaul
Updated10 May 2020
Photo: Hindustan Times
Photo: Hindustan Times

Central banks and governments in the West are trying to prevent deflation in the post-covid world. What if inflation and not deflation becomes the order of the day? Stephen Roach, an economist at Yale University, thinks inflation is the way forward. Mint takes a look.

Why is deflation bad for world economies?

As people have lost jobs, incomes in general and salaries in particular have declined. This has led to a lot of demand destruction. Hence, there is an expectation that deflation will set in as businesses cut prices of goods and services in the hope of getting people to start consuming again. At a simplistic level, an environment where the prices of goods and services are falling should be a good thing, but it is not. As prices fall, people defer their consumption hoping that prices will fall further. This creates problems for businesses, which need to fire more employees to stay viable. This leads to further demand destruction.

Graphic: Sarvesh Kumar Sharma/Mint

How are governments trying to prevent this?

Governments in the West are running huge stimulus packages and spending much more money than they normally would have. With the private sector not spending money as it used to, governments have become the spenders of last resort. The idea is to protect people’s incomes and businesses, especially the small ones, as much as possible. Central banks are pitching in by printing money and cutting interest rates in the hope that people will borrow and consume as much as possible, and businesses will borrow and expand. This is aimed at creating consumer demand and thus ensuring deflation does not set in.

What is the argument that Stephen Roach is making?

Roach believes that consumer demand will be under pressure as people avoid non-essential activities. At the same time, with massive fiscal stimuli being the order of the day, latent consumer demand will build up and explode once a covid-19 vaccine is available. This is different from other views going around, but needs to be considered given the weight of its logic.

What is the basis for him to make the claim?

Roach believes that once a covid-19 vaccine is available, people will go back to doing the things they have always done. This will ensure a rise in consumption. This belief comes with the assumption that governments in the developed world will keep supporting incomes through massive stimuli until a vaccine is available 12-18 months from now. The consumer demand that will spring up at that point of time will lead to inflation because the supply will not be able to keep up with demand. Hence, prices will go up.

Any other reason for inflation to set in?

One fallout of covid-19 has been a disruption in global supply chains and a rise in nationalist sentiment. Hence, countries now want to produce goods at home instead of importing them from China, as was the case until now. This means Chinese exports are likely to fall in the years ahead. It also means countries will manufacture goods on their soil at a higher price, given they do not have the same cost advantage China does. This, in turn, will mean higher inflation.

Vivek Kaul is a Mumbai-based economist.

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