It’s hard to believe in a return to inflation as a significant factor in life for the first time in four decades, but ...
it was equally difficult to imagine that inflation could be vanquished after the brutal experience of the 1960s and 1970s.
For the longer run, I suggest that the building blocks are in place for a change in inflation regime. Society is ready for this, and financial markets are not.
The best summary of where we now stand that I have read this weekend comes from Francis Yared, of Deutsche Bank AG. I commend his following analysis:
The main drivers that have historically generated a regime shift in inflation are in place. Historically, regime shifts in inflation have been driven by fiscal policy (Great Society of Johnson in the mid-60s), monetary policy (Volcker in the late 70s), oil shocks (to the upside in 70s and downside in the mid-80s and 2014), globalization in both labor and goods markets (late 90s) and technology (late 90s).
If we look at the situation today, we had an unprecedented easing of fiscal policy and a shift in monetary policy with AIT. The combination of the two is the proverbial helicopter money – which is the textbook way of generating inflation.
Also, the climate transition is a slow-moving negative supply shock – i.e. it is about incorporating in production prices the cost of carbon emissions. As it disproportionately impacts low-income households, it will require significant fiscal support. This will be a tailwind for inflation.
Finally, peak globalization in terms of labor and goods is probably behind us. This started before Covid with Brexit, tariff wars and restrictions on immigration, and Covid exacerbated this trend.
The technology shock is the only remaining disinflationary force. So of all the historical drivers of a regime shift in inflation, fiscal policy, monetary policy, supply shock to oil prices, globalization and technology, all of them but the latter are supportive of structurally higher inflation.
We made this assessment early last year, and it has since been confirmed by the data. I would highlight in particular the domestically generated inflation: inflation expectations, wages and rent.
Amen to all of that. The destination, almost certainly, is a new, higher inflation regime.
The route by which we get there remains deeply uncertain.
John Authers Bloomberg 31 January 2022
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