When Covid Infection Rates Drop, Inflation Rates May Rise | Business

Andy Haldane made a lot of noise this month when he suggested the economy was like a coil spring waiting to kick in. As the Chief Economist of the Bank of England found out, it’s harder to be a Tigger than an Eeyore. Predictions of impending disaster tend to be forgotten even when they don’t come true. Those who predict that things will turn out well.

Haldane may well be right. Consumer and business confidence is on the rise and if – a big if, admittedly – the government continues to support the hardest-hit sectors appropriately as the economy is released, there is a strong possibility that there is have an explosion in pent-up demand.

But even if Haldane is wrong, it’s important that people make the optimistic cause. It would be far more concerning if the nine members of the Bank’s Monetary Policy Committee (MPC) thought the same way.

The dangers of collective thinking were well illustrated by the 2008-09 financial crisis. Central bankers, investment bankers, the International Monetary Fund and most of the media believe that liberalization of the financial system has made it more secure, while the reverse is the case.

The warning signs of the US real estate market have been ignored. Dangerous levels of risk taking were allowed. All sorts of nonsense has been peddled about how sophisticated financial instruments that few people actually understood would improve everyone’s situation. There has been a collective failure to recognize that anything could go wrong with a supposedly infallible model. Eventually, it was recognized that the herd mentality had led to the virtual implosion of the banking system, but only after the event.

At the time, the maverick voice of the MPC was David Blanchflower, who called for much tougher action to deal with the looming crisis. He got it right.

Currently, there is quite a heated debate among MPC members about what is likely to happen to the economy. Jan Vlieghe, for example, published a speech last Friday in which he considered the possibility of negative interest rates if growth does not meet the Bank’s expectations.

Vlieghe has doubts as to whether the economy is going to have a light switching moment. He fears that the pandemic will continue to affect activity, either directly through restrictions affecting specific sectors or indirectly by making consumers more careful. “It’s perfectly possible that we have a short period of pent-up demand, after which the demand slackens again,” he said.

Haldane takes a different point of view, pointing to a pot of excess savings accumulated over the past year. That stands at around £ 125 billion and, according to the Bank’s chief economist, could double by the end of June. The MPC’s growth projections assume that only 5% of these additional savings will be spent.

“I think there is the potential for a lot more, maybe even most, of this savings pool to seep into the economy, fueling a faster recovery,” Haldane said in his article. for the Daily Mail. “Why? Because people are not only desperate to get their social life back, but also to make up for the social life that they have lost in the past 12 months. It could mean two pub, movie or restaurant visits. per week rather than one. That could mean a high quality TV, car or house. “

If Haldane is right, inflation will resurface as a headache for central banks much sooner than they – or the financial markets – expect. Vlieghe said in his speech that he would prefer to keep the current monetary stimulus – 0.1% interest rate and bond buying via the Bank’s quantitative easing program – in place until 2023-24. Even if the economy is doing better than what the MPC collectively expects, it will not support policy tightening until 2022.

Financial markets got the message. Inflation is not an imminent threat and stimulus measures will not be reversed by central banks until they are confident that their economy is well out of recession.

The IMF supports this approach. Its chief economic adviser, Gita Gopinath, said in a blog last week: “Evidence from the past four decades makes it unlikely, even with the proposed budget package, that the United States will experience a surge in pressure. on prices which constantly push inflation well. above the Federal Reserve’s 2% target. “

Now, it is possible that the uptrend in the stock markets is justified. Headline inflation rates are low and labor markets are slow enough due to rising unemployment to reduce the chances of a wage-price spiral. As far as central banks and finance ministries are concerned, the risks of doing too little outweigh the risks of doing too much, which is why Rishi Sunak will pump more money into the UK economy per week on Wednesday , in the budget.

Yet global stock prices are already at record highs after a decade that was only briefly interrupted by the shock caused when the pandemic arrived early last year. Much of the money created by central banks over the past 12 months has found its way into asset markets, driving up valuations for stocks and properties. Joe Biden’s $ 1.9 billion stimulus package, mentioned by Gopinath, is seen by financial markets as another reason to buy stocks.

Now imagine that the world economy starts to spin due to falling infection rates and political support. Central banks are supposed to remove the punch bowl before the party really starts to swing, but delay doing it. Inflation sets in and central banks are forced to react anyway.

This would be the trigger for a bear market, perhaps quite severe. The idea that financial markets are a one-sided bet because central banks can always be relied on to bail them out is outright group thinking. A gentle warning, that’s all.