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The inflation talk is  heating  up  with trillions at stake

Photo: Hindustan TimesPremium
Photo: Hindustan Times

The financial world is divided on the issue of inflation. One camp is sure that covid-19 has put developed economies on course for rising prices, while the other says the virus is exacerbating the conditions of deflation being a big threat. Here are some of the main arguments.

The financial world is divided on the issue of inflation. One camp is sure that covid-19 has put developed economies on course for rising prices, while the other says the virus is exacerbating the conditions of deflation being a big threat. Here are some of the main arguments.

How does the supply of money hit inflation?

Experts are pointing to the wave of money created by governments to fight the pandemic, and predicting that it will push prices up. “Today’s policy measures are injecting cash flows that will directly raise measures of money," economists Charles Goodhart and Manoj Pradhan wrote in their book The Great Demographic Reversal. The inevitable outcome, as lockdowns ease and recovery ensues, will be “a surge in inflation." However, it’s the use of money, and not just its creation, that affects prices. That’s one explanation for subdued inflation since 2008, even as central banks cranked up the printing presses.

Do household incomes influence prices?

Spending may bounce back faster than it did after 2008, and drive prices higher, as a more aggressive policy response has cushioned the blow to household finances. Fiscal stimulus, unlike the monetary kind, goes directly into people’s bank accounts—where it’s likely to get spent. This opens the door for “demand-pull inflation," according to Stephen Jen, who runs the hedge fund Eurizon SLJ Capital. “Companies with any market power to raise prices will do so." However, incomes may have held up through the recession, but not all the money is getting spent. Savings rates have soared. That’s partly a function of lockdowns.

Pricey affair
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Pricey affair

How is employment related to inflationary pressures?

Policymakers have worked with a trade-off between inflation and unemployment, called the Phillips Curve. The idea is that prices will only face sustained upward pressure when the economy is using all its resources—including labour. That should ease concerns about inflation, as employment everywhere has slumped, with less prospects of a quick rebound.

What is central banks’ role in inflation?

One reason why analysts expect higher inflation is because central banks, the guardians of price stability, are willing to let them rise. The Federal Reserve is likely to announce a new strategy that requires it to be more tolerant when prices overshoot, and refrain from pre-emptive interest-rate increases. The European Central Bank has embarked on a similar review. According to Morgan Stanley economists, “central banks are now committing to make up for some of the lost inflation during downturns."

Are there any other factors at play?

There’s evidence that disruptions to supply chains are pushing prices up. Food inflation has been accelerating in China, and a squeeze on imports is one reason why. Cheap imports, technological advances and corporate giants with the power to suppress wages have been “behind disinflationary trends over the last 30 years," Morgan Stanley economists wrote. Besides, the pandemic has left the supply side of the economy intact. Hence, once activity swings back to normalcy, excess capacity can trigger deflation.

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