Inflation To Hit 3%: Spence Argues
Coverage from the current online debate on Inflation Risk.
BY Andrew Spence | March 16, 2010
Coverage from the current online debate on Inflation Risk, pro viewpoint;
The proposition for this debate states that policymakers around the world have responded to the financial crisis through massive fiscal stimulus. As governments determine how best to withdraw all the money they pumped into the system, many economists believe that sooner or later, there’s got to be a big upsurge. Severe inflation is on the horizon and plan sponsors should be prepared.
Since inflation targeting swept central banks in the early 1990s, inflation has trended down to set-in at about 2%, acceptable to most central banks. The 2007-2008 financial crisis was the biggest economic shock in our lifetimes, breeding widespread global deflation expectations.
The global policy response was swift and overwhelming. Fiscal stimulus of 5% of global GDP augmented interest rates at the zero bound in countries that account for most global demand. Moreover, central banks immediately invoked quantitative easing, delivering enough liquidity to prevent both prevent insolvency and to break deflation expectations.
Monetary policy is working through asset prices where financial systems are broken. Credit growth is taking demand higher in jurisdictions with well regulated financial, but in the U.S., the U.K. and Europe, policy monetary policy effectiveness is hard to gauge and confidence in a capacity-absorbing upswing is low. Policy makers will be slow to tighten policy, and, will want to have evidence we are out of the woods before moving.
Quantitative easing has no interest rate equivalent to guide policy. The probability of – and impact of – any monetary policy error is unusually large, especially in the U.S. and the U.K. And, as observed by one former central banker, “Are the macro guys still in charge”? The financial crisis took us across the fine line dividing fiscal and monetary policy, potentially diminishing central bank independence.
Policy stimulus was large and indiscriminate. Growth and inflation languish in the G3, but in emerging Asia both are resurgent. Asia’s ability to choose between exchange rate repression and inflation management is constrained. The fiscal challenges created from cleaning-up the financial mess have already arrived. Choosing between winners and losers to correct debts and deficits is tough and policy makers could resort to the inflation tax to make ends meet.
Today’s inflation risk is the biggest since the 1980’s, and once clear of today’s dis-inflationary slack – in 2011 and beyond – inflation could well reach above 3%. While central banks might be willing to contain it, will they be able to? What are your thoughts on where we’re headed?
To view Terence Yuen’s (senior economist with Towers Watson) opposing view point, join the debate.