Are fears of inflation justified?
After years of low inflation in Europe and the US, are we about to see a dramatic uptick in inflation? In his recent Spiegel column, Henrik Müller, Professor of Economic Policy Journalism at the Technical University of Dortmund, argues we shouldn’t rule out the possibility.
[You can read his full March 28, 2021 column in Der Spiegel here (in German).]
[Text in blue below has been translated from German by Randal Gernaat.]
Professor Müller starts by (correctly) admitting that "inflation is a perennial topic in Germany, even when there is no sign of it." Inflation fears were clearly unjustified following the 2008 financial crisis when Germany (among other countries) insisted on austerity for hard-hit southern European economies and followed a strict “schwarze Null” policy of no deficit spending.
As we dig our way out of the effects of the coronavirus crisis, however, we find ourselves in a different situation. Governments around the world have stepped up spending in an unprecedented manner to combat the effects of the crisis.
Professor Müller points out that surveys conducted in Germany repeatedly show average citizens have been unable to accurately gauge actual inflation rates. “Inflation expectations, as calculated by Bundesbank surveys, were generally much higher than the actual inflation rates that were later reported. Expectations were between two and three percent. But the cost-of-living index calculated by the German Federal Statistical Office rose much more slowly, sometimes it even sank."
Fear of inflation is picking up again, but "there is an important difference this time around: professional forecasters now agree." He argues that "after years of extremely low inflation rates, we are on the cusp of a turning point."
Government bond yields are starting to tick up, but rates remain relatively subdued. Professor Müller sees two reasons why inflation fears may be more justified this time around. "Either economic policy decision-makers are completely wrong in their assessments and will themselves be surprised by a sharp rise in prices. Or political systems are vulnerable to governments who don’t know what else to do other than to let inflation run wild and use the printing press to finance public expenditures. Sometimes both situations occur simultaneously. There are abundant examples of this, both historically and currently."
Weak political systems leading to higher inflation is something that has mostly occurred in the developing world. But Professor Müller makes a compelling case that due to weak or damaged political systems in the Western, developed world, we can no longer assume it can’t happen here.
Both the US and the European Union are planning historically high spending levels to combat the aftereffects of the coronavirus crisis. Given divided electorates and weaker political systems, governments are likely to struggle to find sustainable ways to pay for all this spending. "The deeply divided American nation is unlikely to be able to agree on fundamental structural reforms and tax increases, but perhaps they can agree on spending money hand over fist."
There are "signs of institutional disintegration and internal weaknesses on both sides of the Atlantic. Politics in many countries is polarized, citizens are losing faith in government institutions. And the performance of governments, parliaments and the EU Commission during the coronavirus crisis raises the alarming question of whether governments are still capable of functioning properly, including in Germany."
At the end of the day, we may be reliant on central banks to prevent us from falling into an inflationary spiral as we saw in the 1970s. "Central banks can implement countermeasures: cut back on bond purchases, raise interest rates. This won’t make them very popular, but that’s not part of their job description. The most important thing is that they continue to command the necessary respect."
