Fed Chairman Jerome Powell at a press conference (archive): Let things go for a while
Photo: Kevin Lamarque / REUTERSThis week, Jerome Powell, head of the US Federal Reserve, announced that he would aim for higher inflation rates in the future. Sometimes anyway. Times with very weak price dynamics, as is currently the case, should be followed by phases with more inflation.
In the future, the Fed will no longer necessarily want to take countermeasures if the rate of price increases exceeds two percent, but rather let things run for a while. The two percent threshold should only apply over the longer term.
"Many find it counter-intuitive that the Fed wants to push inflation up," Powell said at this year's central bankers meeting in Jackson Hole, Wyoming. This is not an understatement.
To the author
Institute for Journalism, TU Dortmund
Henrik Müller is professor for economic journalism at the Technical University of Dortmund. Before that, the graduate economist worked as deputy editor-in-chief of manager magazin. In addition, Müller is the author of numerous books on economic and monetary issues. Every week he gives a pointed outlook on the most important economic events of the week for SPIEGEL.
The rising cost of living is a major personal concern of citizens. Also in Europe: no other topic drives citizens' private experiences as much as rising prices, as the Eurobarometer survey from autumn shows.
Nevertheless, central banks have been trying to raise inflation rates for years. The European Central Bank (ECB) has stepped up its measures against the Corona recession. ECB chief economist Philip Lane explained the European response to the crisis in Jackson Hole, among other things, by wanting to achieve the medium-term inflation target of just under two percent.
Literally it was said that one wanted to "neutralize pandemic-related downside risks for the inflation path". This means that the ECB is aiming for higher inflation rates than currently. (Watch out for new numbers for Germany and the eurozone as a whole on Monday and Tuesday).
Well, popularity is not necessarily part of the job profile of a central banker. In the past, when inflation rates continued to skyrocket, they regularly made themselves unpopular when they raised interest rates and thereby stifled growth. Today, when the price increases are extremely small, they are determined to want to push inflation. It's never easy.
Rising prices or rising debts?
The central bankers' most important argument against low inflation is a technical one: They worry about the ability of the economy to steer. With zero inflation - or even deflation, i.e. falling prices - and correspondingly ultra-low interest rates, central banks can no longer support the economy in times of crisis.
That is why the major central banks are currently buying more securities than ever before. Interest rates are zero, and deposits at the central bank even incur penalties in the euro zone and elsewhere. So the central banks pump money directly into the financial markets. But in the long run this instrument seems to lose its effectiveness - which is why the purchase volumes have to keep increasing in order to achieve effects.
If inflation rates remain as low as they are now, Fed Chairman Powell said, "in the economic downturn, we would have less room to cut interest rates and support employment, which would further reduce our ability to stabilize the economy." There are similar concerns elsewhere.
In addition, there is another problem that central bankers do not like to talk about: The debts of states, companies and private citizens were already high before the Corona recession - a late consequence of the financial crisis of 2008/09. Now the liabilities have shot up even further. The question now arises of how the financial situation of entire national economies can be stabilized in the long term.
The best way out looks like this: moderate inflation combined with decent economic growth. A booming economy could simply expand out of debt. This has worked before: In the decades after the Second World War, the USA and Great Britain, both of which were initially heavily in debt, created financial leeway in this way.
Unfortunately, this trick is not that easy to repeat. The example of Japan shows that even a combination of extremely expansionary financial and monetary policy is not necessarily sufficient to fuel economic growth and price dynamics sufficiently and to reduce the debt burden. Japan's national debt last year was 240 percent of economic output (compared to Germany: 70 percent). The average inflation rate over the past ten years has been just under 0.5 percent. Open end. However, many countries are now following a strategy similar to that of Japan. Are we on the wrong path?
The historical norm: price stability
If you look at inflation over very long periods of time, you can see clear structural breaks. The country with the longest time series is Great Britain. It begins in 1661. Since the UK was the first economy to make the leap to industrialization and has long been considered a world leader, the results are interesting beyond the UK.
Various phases can be seen in the data. The first takes a long time, around the middle of the 19th century. In this era, rates fluctuate wildly between inflation and deflation: Prices rise by 15 percent in one year and then decrease by 14 percent in the following.
These ups and downs are driven by agricultural prices: In a predominantly poor, agricultural economy, in which people have to spend a large part of their income on food, good and bad harvests have a brutal impact on the total cost of living. The beginning of industrialization also causes short, hard fluctuations: strong demand in one year, overproduction, full stocks and layoffs in the next.
On the long-term average, however, price stability prevailed. In the period between 1661 and the middle of the 18th century, the inflation rate averaged 0.5 percent annually, in the era of early industrialization (around 1750 to 1850) it was 0.7 percent, and then in the following decades up to the First World War at an average of 0.2 percent.
In the period between the mid-19th century and 1913, however, something interesting happened: the deflections became smaller. There is a calming down of the macroeconomic variables. Economic historians today refer to this phase as the first globalization. National overproduction could be sold abroad, temporary shortages could be alleviated by imports. Open borders and fixed exchange rates (within the framework of the gold standard) ensured that macroeconomic variables and thus prices also settled down.
After the first globalization
This era was ended by the First World War: the borders are closing, the switch to war production and financing causes inflation to skyrocket. Something similar was repeated in World War II.
After the great catastrophes of the 20th century, Western economies are starting to trade with one another again, albeit tentatively. In the 1950s and 1960s, the currencies were pegged to the dollar, which in turn was backed by gold. Inflation is moderate in these years.
This phase ends at the beginning of the 1970s when the gold-dollar pegging system collapses and the oil crises of 1973 and 1979/80 put considerable pressure on prices. In Germany, inflation rates peak to seven percent, in Great Britain even to 23 percent.
From the 1980s, the central banks gradually learn to get inflation under control. This process is supported by the growing importance of the service sector, including the state, which is subject to lower price fluctuations, as well as by the second globalization from the 1990s.
A new era of great calm begins, similar to what happened in the second half of the 19th century. Open borders and intense competition limit the scope for price and wage increases. The inflation rates are now low again and are converging between the western economies. It is the time when the two percent norm begins to prevail.
After the financial crisis of 2008/09 and the severe recession that followed, this trend has continued: The trend towards inflation rates continues to decline, even in countries with acute labor shortages such as Germany. Last year consumer prices rose 1.8 percent in the US and the UK and 1.2 percent in the euro zone. The central banks are now trying to approach the two percent target from below.
The corona crisis encounters this constellation: an initially severe slump in economic output, combined with - presumably - lasting changes in economic structures.
"We would not hesitate to act"
The picture on the financial markets is currently mixed: On the one hand, there seems to be an expectation that inflation rates will continue to fall - which can be seen from the negative interest rates on many bonds. On the other hand, many investors are obviously concerned about currency depreciation - which would explain the historically high gold price. Who is right?
I'm guessing that the second bearing is right. Of course I'm by no means sure.
Looking back at the history of inflation suggests that price stability, in the long run, is the norm. So it is conceivable that we will return there. A few current developments also speak for this: The aging of societies in the west and in many emerging countries is dampening demand because citizens save more, that is, they tend to ask less. Then there is the rapidly advancing digitization, which also tends to depress prices and wages.
This is countered by the fact that inflation is typically associated with political stress situations. In the 20th century, the two world wars and the oil crises led to accelerated currency devaluation. State collapses even imploded the entire monetary order in some countries.
In fact, the present is characterized by severe crises: the previous international system, including global institutions, is in the process of dissolving. The struggle between the US and China for supremacy will outlast Donald Trump's presidency. Whether globalization will continue is an open question. If borders were closed again, this could fuel inflation.
So far, the liquidity pressure generated by the central banks has been released more on the capital than on the goods markets: stocks, bonds and real estate are becoming more expensive, while the measured cost of living remains largely stable. But uncertain about the world situation, the framework conditions can change quite radically - with rapidly rising prices as a possible consequence.
Fed Chairman Powell clearly has such a scenario in mind. "Should excessive inflationary pressures build up," he protested in Jackson Hole, "we would not hesitate to act." But given the political pressure and the high level of debt, that's easier to say than done.
The main economic events of the week ahead
Monday Up Arrow Down Arrow
Berlin - On the run - While the alleged main mastermind of the Wirecard scandal is still on the run, the finance committee of the Bundestag meets for a special session.
Wiesbaden - The prices in August - The Federal Statistical Office announces the inflation rate for August.
Geneva - Departure - The Director General of the World Trade Organization (WTO) Azevêdo is leaving his post. A successor is still unknown.
Tuesday Up Arrow Down Arrow
Potsdam - Demands - Beginning of the collective bargaining round in the public service of the federal government and municipalities. The unions are demanding heavy surcharges, especially for lower income groups.
Nuremberg / Luxembourg - Jobs - The Federal Employment Agency announces labor market figures for August, the EU agency Eurostat publishes figures on unemployment in July.
Luxembourg - Euro prices in August - Eurostat presents figures on inflation in the euro area.
Essen - bankruptcy - meeting of creditors of Galeria Karstadt Kaufhof GmbH.
Wednesday Up Arrow Down Arrow
Sindelfingen - Schlitten - World premiere of the new Mercedes S-Class and opening of the new "Factory 56" plant in Stuttgart.
Thursday Up Arrow Down Arrow
Frankfurt - Germany economy - New figures on incoming orders in mechanical engineering.
Friday Up Arrow Down Arrow
Washington - US Economy - US Unemployment Rate Publication for August.
