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Home >Opinion >Columns >A big reason for the permanent rhetoric of transitory inflation

By all accounts, inflation—an acceleration in the prices of a representative basket of consumption goods and services—has arrived in most Western countries. The rate of headline inflation in the US, for example, is 5.4%. Core inflation in the US—the rate of inflation in all consumption goods and services excluding food and energy items—is 4.5%. Quite apart from the prices of consumption goods and services, the Institute for Supply Management in the US reported that its index of prices paid by factories for inputs and materials stood at 92.1, its highest level since 1979.

Inflation expectations culled from bond prices may not be alarming, but they too show that expectations are on the rise. The 5-year break-even inflation rate at 2.5% in the US is higher than it has been at any time since the early noughties. The 5-year/5-year forward inflation rate—a measure of expected inflation (on average) over the five-year period that begins five years from today—however, has peaked and has dipped from a high of 2.34% in May to 2.14% recently. So, the question is not whether prices are rising at an accelerating rate but whether such acceleration will be entrenched. In other words, will it be transitory or permanent. Unfortunately, we don’t have a clear answer yet.

A bulletin issued by researchers at the Bank for International Settlements (‘Global reflation?’, BIS Bulletin No. 43, 15 July 2021) notices fewer signs of a permanent pickup in the inflation rate. In its view, three things are associated with persistent inflationary episodes: namely, sustained demand in excess of supply, sustained wage increases in excess of labour productivity growth, and a de- anchoring of inflation expectations. The first one is handled easily by central banks. The second and third are not pervasive yet. As for wage growth, the BIS reviews evidence of whether labour compensation per employee is out of line with its pre-pandemic trend (2017-19). That is not out of line anywhere except the US, where it could be skewed by the fact that low-income jobs were eliminated during the pandemic and hence labour compensation per employee appears to have gone up appreciably. So, nothing to see here either, says the bulletin.

However, after studying pandemics dating back to the 14th century, professors Jorda, Singh and Taylor (‘Longer-run economic consequences of pandemics’, February 2021) conclude that pandemics do not destroy capital but induce labour scarcity and hence a rise in wages. John Authers wrote that the historical evidence is strong on pandemics improving the negotiating positions of workers, even excluding the Black Death and later the Spanish Flu of 1918 which provided unmistakable evidence in support of that hypothesis. The ratio of wages to the S&P 500 index began rising after the end of the Spanish Flu. Yes, there was war then. Now, globalization is retreating, populations are ageing and the deflationary effect of e-commerce may be plateauing. Will they be enough to light a fire under wage growth?

The question of whether labour costs would go up more than the rise in labour productivity is answered neither by statisticians nor economists, but by politicians. Politicians have, by and large, stuck to providing generous unemployment benefits in the US, although some states have begun withdrawing them. A poll released last Wednesday suggested that nearly 1.8 million Americans have turned down job offers because of generous unemployment benefits and that signing-on bonuses of around $6,000 were offered to drivers and mechanics.

A very insightful paper (‘Beyond Automation: The Law & Political Economy of Workplace Technological Change’, February 2019) by professor Brishen Rogers at Temple University School of Law points out that employers use technological advancements not so much to replace labour with automation and machines, but to control them and keep them insecure. He makes the case for changes in employment laws that would strengthen the hands of workers. Doles to unemployed workers, financed by central banks, is one thing, but tilting the power balance towards labour is another thing altogether. We don’t know if that will happen anytime soon in America.

The upshot of all these is that they create conditions for central banks to maintain a permanent state of accommodation, so that ‘transitory’ inflation eventually becomes permanent but without being recognized as such. Unanticipated inflation serves the purpose of redistribution from savers and lenders to borrowers, and the rhetoric of transience helps to keep inflation unanticipated and unincorporated in financial and wage contracts such that the real cost of borrowing and real wage growth remain negative. The public-debt mountain must be whittled down. Eventually, in the second half of the decade, the inflation rate will reach a permanently high plateau, bringing down government debt ratios meaningfully, as seen in the second half of the 1970s. Doubtless, there will be other costs to this policy, not all of which can be anticipated now. For now, policymakers have concluded that the overriding policy priority of this decade is stealth reduction in real debt burdens. Therefore, expect the rhetoric of transitory inflation to achieve a measure of permanence.

V. Anantha Nageswaran is a member of the Economic Advisory Council to the Prime Minister. These are the author’s personal views.

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