Mid Week Bond Update

Inflation: This Time it’s Different?

Global Thought Leadership
4 June, 2020

Is the global monetary and fiscal COVID-19 rescue setting up a future of global inflation?

The global policy response to the crippling impact of  COVID-19 pandemic has been unprecedented in both magnitude and speed. Lessons learned after the 2008 financial crisis were rapidly put into action worldwide in both monetary and fiscal terms, with post-GFC financial reforms contributing to the relative stability of the global banking system so far.

The 2008 experience has helped mute worries about the inflationary effects of massive monetary easing; none of 2008’s feared rapid inflation came to pass, even as the economies and financial markets recovered

In the short run, a feared return of a 1930s style years long depression might have been averted, according to Brandywine Global’s Brian Giuliano:

“The environment today is not entirely dissimilar from the early 1930s, the last time a demand shock of a similar magnitude occurred. Chart 1 shows what happened to the Consumer Price Index (CPI) in the immediate aftermath of the Great Depression (1930-33). The good news is that today, unlike the early 1930s, policymakers seem to understand the gravity of the situation, and are acting to aggressively combat both the fall in real output and intensifying deflationary pressures.”

                                                            (Excerpted from Fighting Deflation Now, Causing Inflation later?

U.S. CPI Inflation, 1927 – 1934

% As of 3/31/2020

Source: Haver Analytics. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

But there is a potential worry: the temptation to lose the discipline of central bank independence, in the form of:

“…outright financing of government deficits by central banks—some form of Modern Monetary Theory (MMT). Recently, the Bank of England agreed to directly finance the U.K. Treasury for a small amount, over a short period in response to the COVID-19 crisis. While this small action seems harmless, and unlikely to spur inflation, the risk is that once the door is opened, it’s hard to walk back from it. In today’s politically charged environment—and considering how much debt is outstanding—there’s no saying how “creative” politicians might get to finance deficits. What’s easier to sell to constituents: raising taxes and cutting pensions, or having the central bank coordinate policy with the government? Any move to give central banks the power to spend, would be quite negative and inflationary for the country that chooses to walk down this path.”


Definitions

COVID-19 is the World Health Organization's official designation of the current novel coronavirus disease. The virus causing the novel coronavirus disease is known as SARS­CoV-2.

A pandemic is the worldwide spread of a new disease.

The Great Depression was the worldwide economic downturn that began in 1929 and lasted until about 1939. It was the longest and most severe depression ever experienced by the industrialized Western world, sparking fundamental changes in economic institutions, macroeconomic policy, and economic theory. Although it originated in the United States, the Great Depression caused drastic declines in output, severe unemployment, and acute deflation in almost every country of the world. Its social and cultural effects were no less staggering, especially in the United States, where the Great Depression represented the harshest adversity faced by Americans since the Civil War of the 1860s.

The Great Recession, also known as the financial crisis of 2007–08, the Great Financial Crisis (GFC), global financial crisis and the 2008 financial crisis, was a severe worldwide economic crisis considered by many economists to have been the most serious financial crisis since the Great Depression of the 1930s, to which it is often compared.

The Consumer Price Index (CPI) measures the average change in U.S. consumer prices over time in a fixed market basket of goods and services determined by the U.S. Bureau of Labor Statistics.

Modern Monetary Theory (MMT), not widely accepted, has the following basic attributes: A government that prints and borrows in its own currency cannot be forced to default, since it can always create money to pay creditors. New money can also pay for government spending; tax revenues are unnecessary. Governments, furthermore, should use their budgets to manage demand and maintain full employment (tasks now assigned to monetary policy, set by central banks). The main constraint on government spending is not the mood of the bond market, but the availability of underused resources, like jobless workers.

The Bank of England (BOE) is the central bank of the United Kingdom.

Her Majesty's Treasury (HM Treasury, or UK Treasury), sometimes referred to as the Exchequer, or more informally the Treasury, is the department of the Government of the United Kingdom responsible for developing and executing the government's public finance policy and economic policy.

Gross Domestic Product (“GDP”) is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

The International Monetary Fund (IMF) is an international organization with 189 member countries, established to promote international monetary cooperation, exchange stability, and orderly exchange arrangements.

Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

The European Central Bank (ECB) is the central bank for the European Union (EU).

 

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