Across the rich world inflation is raging by about 9% year on year. This constitutes the highest rate of inflation the rich world has seen since the early 1980’s. The last time inflation was this high, it ran for about sixteen years from its inception in the mid 1960’s to the recession in 1983. But is there an aura of complacency setting in with the public growing to expect consistently high inflation?
Public Perception of Inflation: One of the problems facing the financial industry is that the average person is not tuned in to monetary policy, and may not know how interest rates are used to fight a problem like inflation. The concept of what constitutes inflation may also be misunderstood. Most consumers can see rising prices when they go to shop, but not that many fully understand what causes prices to rise up. The value of the products being purchased is basically the same as it was before inflation, but the value of the money that’s used to buy them is falling, therefore requiring more money to buy the same thing. Further, as many as 37% of Americans believe that the President of the United States has a substantial amount of control when it comes to dealing with inflation, compared with only 34% who believe that the Federal Reserve has the upper hand. This uncertainty on the part of the public is not confined to America. In Japan, the central bank has been using quantitative easing to help boost inflation to protect the currency against deflation, which could arguably be worse. However, more than 40% of the population had never heard of any plan to fight deflation via quantitative easing. In its own way, the public’s apathy towards central bank’s monetary policy during the last forty years reflects on its success during that period. Nobody was suffering as a result of inflation, so few people were even concerned. It could be a more difficult problem for today’s politicians to motivate a society to deal with inflation and to do so quickly before it gets way out of hand.
Revisiting the Previous Inflation War: The U.S. population has gone through two generations since the previous bout of inflation that came grinding to a halt with the recession in 1983. That recession was short and sharp, but the interest rates were very slow in getting back down to their pre-inflation levels. Home loans were particularly creative with interest only being paid monthly and balloon payments set for a date in the future. The concept was that the homeowner could hold onto the mortgage if he could manage to pay just the interest payment. Then in the future, when presumably rates returned to normalcy, the mortgage could get refinanced at a lower rate, and the repayments of principal could begin. Today’s younger generations had the advantage of growing up in an economy that did not feature inflation. Most of the baby-boomer generation had to cope in one respect or another with nagging inflation that carried on for about sixteen years before Fed Chairman Paul Volker brought it to a close with interest rates reaching upwards of twenty percent. For many during that period there were employment difficulties that were compounded by the large numbers of job-seekers between the ages of twenty and thirty-seven competing for few available jobs.
Policy Tactics to Fight the Current Inflation War: President Joe Biden has said that fighting inflation is his top economic priority. Central banks and fiscal policy makers throughout the rich world need to let the investing public in particular know that they are serious about fighting inflation and will take it on in spite of any recessionary risks that might crop up. One of the best policy positions taken in recent times to fight inflation came during the Eurodollar debt crisis in 2012. Mario Draghi, the head of the European Central Bank, promised to do “whatever it takes” to save the Euro. This struck at the heart of inflation, as support for the currency is critical; and by calling the public’s attention to it, he shifted their attention away from buying bonds that provided the means of support for the currency. Another policy tactic that has shown some success is to “ambush” inflation by raising interest rates outside of the sphere of the central banks’ regularly scheduled meetings. The period of weeks leading up to the a regularly scheduled rate hike announcement can be full of speculation. When the announcement is finally made, markets will often recoil and shift in directions different from investors had anticipated. If a surprise meeting were held and an unanticipated raise in interest rates announced, this period of speculation and anticipation could be reduced to nearly nothing, and the markets would then be more likely to react in a manner that is better understood by investors. Policy efforts in the 1970’s included President Nixon’s wage-price controls, and President Ford’s vetoing spending bill after spending bill. Such tactics do not appear to be necessary at this point, but fiscal policy needs to get back under control to augment monetary policy.
Policy’s Impact on Stock and Bond Markets: In today’s investment world, the big money from large funds and investment institutions that drives the markets is typically managed by computers to take advantage of the speed with which an individual order reaches the market’s queue and is executed. This can help maximize the trader’s price, but during unanticipated shifts in policy, this process can come to an abrupt halt as the computer programs and algorithms that drive it need to be updated with the new set of input values. The corresponding increase in time may be short, but it can upset the race to who’s trade order is first into the market’s queue. By being even a nano second late it could impact the investor’s strategy that was designed to work with a certain price that was changed before his trade order was executed.
Conclusion: Inflation is like fire. When it’s under control it can provide heat, light, and energy. Too little, and the economy freezes—too much, and it burns up. To fight a fire, those involved need to get to the problem and begin working right away to take care of it. The Federal Reserve perhaps dabbled with the current inflation for several months before acknowledging that it was in fact a problem and needed action right away. The concept put forth that this inflation is “transient” implied that it will go away by itself. Nothing in the world of public economic policy could be more dangerous than to live by that axiom.
Sources: The Economist, Free Exchange | Into a void, June 25th 2022.