Starting tomorrow in Global Trends, we will begin to study risks and imbalances in a multipolar world. We will start with the rise of new geopolitical actors, move on to the emergence of new voices and interests, then study economic risks stemming from debt and aging, and conclude with a module on global environmental and health risks.
One aspect of risks and imbalances that has recently emerged at the forefront of the economic debate in the United States is inflation. Inflation worries have been present ever since the Fed started its unprecedented program of monetary easing in the aftermath of the Global Financial Crisis of 2008, and since the US Federal Government started running historically large budget deficits in the same period. These worries never materialized. In fact, if anything, inflation remained mostly below the Fed's guideline of 2%.
Recently however, new worries have emerged. In my view, the circumstances justify these worries. As of early 2020, the US economy was operating at or close to full employment, with pretty solid GDP growth. Then the pandemic hit. The pandemic was not your typical demand shock, where people suddenly curtailed demand. Rather, it was akin to a supply shock, where production was ordered halted (at least in some sectors like travel, entertainment, etc.). People wanted to consume these goods, but it was forbidden. In the wake of this situation, the US government did what it knows best: the Fed injected massive amounts of liquidity, and Congress authorized massive amounts of public spending, financed by debt. While this did not prevent some businesses from shuttering, it at least preserved the banking sector's access to liquidity and also supported consumer disposable income. The issue is what happens once the pandemic eases and people's pent-up demand becomes manifest. In supply and demand terms, there will be a shift outward in aggregate demand, but with a lot of business shuttered and capacity having become restricted, supply will be for a time inelastic. This is a recipe for rising prices. The broad availability of liquidity may render this inflation possible, and politicians will have enabled the increase in aggregate demand by making sure that household's spending power was preserved - even perhaps increased.
This is the nature of the debate. Some argue there is no sign of inflation. Others see the first indications of rising prices: businesses seem less inclined to offer discounts, which is not crazy since consumers' spending power seems very robust. Others point to the lessons of history. This excellent Bloomberg article by Ferdinando Giugliano makes the point eloquently (if you must click on only one link from this post, let it be this one; the article is very close to my own thinking on the matter). The issue is not what we see in the price data now; we are still largely in lockdown mode. The issue is what will happen when we reopen. Don't you want to go shopping, to the restaurant, and take a lavish trip somewhere? I sure do! If many do that, combined with lax monetary and fiscal policies and mounting public debt, all the conditions for a return of inflation will be fulfilled.
It is in this broad context that two leading economists, Larry Summers and Paul Krugman, recently debated the Biden administration's efforts to pass a $1.9 trillion stimulus package. Summers is worried this is too large, and will fuel inflation while crowding out future spending requirements (particularly on public investment in infrastructure and health). Krugman was initially more dovish, but as the conversation evolves you will see that the two economists are not that far apart. What is notable, of course, is that they are not known as being particularly skittish about monetary accommodation and fiscal profligacy. But they are first and foremost good economists, and I think they understand we are entering uncharted territory.
You can watch their brilliant exchange here:
UPDATE: My previous post on macroeconomic risks and the possible rise in interest rates that is coming is here. As of February 25, 2021, we are witnessing a worrisome spike in 10-year Treasury yields. Don't say I did not warn you!
On a global level, US inflation has a domino effect on emerging markets as well. The inflation risks are already triggering currencies. Currencies backed by hawkish central banks e.g the Brazilian real, Chinese yuan, Czech koruna and South Korean won — along with oil exporters, most notably the Russian rouble and Russian equities seem like a way to benefit
https://www.cnbc.com/2021/02/15/bank-of-america-names-the-emerging-market-currencies-to-back-as-inflation-risks-mount.html
Posted by: Aadit shah | 02/21/2021 at 07:58 PM