Great moderation can lead to a dangerous new era of stagnation

There is debate as to whether inflation over the next few months will be temporary, reflecting a sharp bounce-back from the Kovid recession, or a persistent, demand-pull and cost-push factor. Many arguments point to a sustained secular rise in inflation, which is well below the annual 2% target of most central banks for decades. First, the U.S. has implemented a high economic stimulus for the economy, which already appears to be recovering faster than expected. The additional $ 1.9 trillion spent approved in March came on top of a $ 3 trillion package last spring and a $ 900 billion stimulus in December and will soon be followed by a $ 2 trillion infrastructure bill. The US response to the crisis was larger than its response to the 2008 global financial crisis.

The counter-argument is that this stimulus will not trigger permanent inflation, because homes will save most of it to pay off debts. In addition, infrastructure investment increases not only demand but also supply by expanding the stock of public capital that increases productivity. However, in reality, if these dynamics are taken into account, the inflation of private savings brought about by the stimulus indicates that there will be some inflational release of pent-up demand.

Second, the relevant argument is that the US Federal Reserve and other major central banks are increasingly accommodating policies that combine monetary and credit easing. The liquidity provided by the central banks has already led to asset inflation in the short term and as the financial reopening begins and the recovery accelerates inflation will increase credit growth and real spending. When the time comes, some argue that central banks can raise extra liquidity by drawing up their balance sheets and raising policy rates from zero or negative levels. But this suit was very hard to swallow.

Central banks are monetizing large cash deficits in the application of ‘helicopter money’ or modern monetary theory. While public and private debt is already rising from a high baseline (425% of GDP in developed economies and 356% worldwide), only a combination of low short- and long-term interest rates can keep the debt burden stable. At this point monetary policy normalization will crash the bond and credit markets, and then the stock markets will go into recession. Central banks lost independence.

Here, the counter-argument is that when economies reach full capacity and full employment, central banks will do anything to maintain their credibility and independence. The alternative is de-anchoring inflation expectations, which would destroy their reputation and allow runaway prices to rise. The third argument is that making money through monetary deficits is not inflation; Instead, it prevents every inflation. However, the shock that hit the global economy when an asset bubble ended in 2008 created a credit crunch and assumed that the overall demand was similar to the shock.

The problem today is that we are recovering from a negative total supply shock. Therefore, excessively loose monetary and economic policies can actually lead to inflation, or, worse, stagnation (high inflation along with recession). After all, the stalemate of the 1970s came after the 1973 Yom Kippur War and two negative oil supply shocks following the 1979 Iranian Revolution. In today’s context, we need to be concerned about many negative supply shocks such as threats to potential growth and factors that increase production costs. These include trade barriers such as globalization and growing protectionism; Post-pandemic supply barriers; Deep Sino-American Cold War; And the balconization of global supply chains and the shift of foreign direct investment from low-cost China to high-price locations.

Population structure is of equal concern in both emerging and developing economies. As older peers increase consumption by spending their savings, new restrictions on immigration are pushing upward labor costs.

In addition, growing income and wealth inequalities mean that the threat of popular setbacks remains within the game. On the one hand, it can take the form of economic and regulatory policies to support workers and unions, which puts more pressure on labor costs. On the other hand, the concentration of oligopolistic energy in the corporate sector also proves inflation, as it increases the price power of producers. And, the setbacks against Big Tech and Capital-intensive, labor-saving technology could further reduce innovation.

There is a counter-narrative to this stagnation theory. Despite the public backlash, technological advances in artificial intelligence, machine learning and robotics continue to weaken labor and replace population influences by a higher retirement age (indicating a larger labor supply).

Similarly, the recession of today’s globalization is due to the intensification of regional integration in many parts of the world, and the outsourcing of services provides solutions for barriers to labor migration (no need to go to Silicon Valley to design a programmer in India US application). Finally, any reductions in income inequality will fight against the global stagnation of demand and every inflation, rather than severe inflation. In the short term, a slowdown in the commodities, labor and commodity markets, and in some real estate markets, will prevent continued inflationary growth. Over the next few years, loose monetary and economic policies will begin to induce sustained inflation and eventually stabilize-pressure due to the emergence of sustained negative supply shocks.

Make no mistake: the return of inflation can have serious economic and economic consequences. We have moved from ‘Great Moderation’ to a new era of gross instability. The secular bull market in bonds is finally coming to an end and rising nominal and real bond yields will make today’s debt unsustainable, crashing global equity markets. At the appointed time, we can also see the return of the 1970s-style illness.

(Nouriel Roubini is a professor of economics at the Stern School of Business at New York University)

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