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How has inflation disappeared from the world, and when - if at all - will it return

Despite the massive inflows of money into the world economies over the last decade, inflation remains very low, in fact contrary to what can be expected from economic laws.

Why is inflation not raising its head, what are the expectations of the relevant markets and what do the world's central banks want to happen?

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• inflation

Deer Stepak

Thursday, February 25, 2021, 9:30 p.m.

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One of the mysteries that has fascinated the world of economics since the great global crisis of 2008 is the question of how it was that the massive inflow of funds, designed to soften the intensity of the crisis, and was necessary, did not lead to high inflation rates.

A mystery, because economics has always warned of the catastrophic consequences of injecting funds of enormous magnitude as they were.

Moreover, with the decline in unemployment rates until the eruption of the corona, we would have expected a low unemployment rate to cause wage pressures and inflation in line with the known Phillips curve, but in practice this has not happened.

That relationship has disappeared and even the Fed recently announced that it is abandoning the Phillips curve.

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Abandon the Phillips curve.

Fed President Jerome Powell (Photo: AP)

Although inflation did not disappear completely, it was very low.

In the Eurozone, for example, the average annual inflation in 2009-2019 was 1.3%, and in the United States 1.8%. Israel enjoyed extremely low inflation rates: 1.1% on an annual average. Annual inflation in all years before the crisis (2000-2008) and cash flows The enormity was higher.In

retrospect, economists found four main explanations for the lack of impact of cash flows on the level of inflation.

• One - the funds that flowed, which were intended, among other things, to save the financial system and at its center the banks, remained in the banks, which were not in a hurry to release them as loans to consumers and businesses, for fear of repaying them.

  The supply of the wide money aggregate (M3) has increased very gradually.

• The second is the low inflation rates due to technological developments.

  Indeed, there is no doubt that technological innovation has enabled companies to become more efficient and improve their competitiveness while reducing the prices of their products and services.

  There are quite a few services provided for free.

• Third, the cost of production has remained low both in China and in emerging markets, both in Eastern Europe and in Western Europe, thanks to the massive migration to it, which has hampered the bargaining power of Western European workers.

• Fourth - it is not really that inflation has disappeared.

  It has indeed disappeared as far as the consumer price index is concerned, but it has entered into the prices of shares and bonds, that is, into the prices of financial assets, and yes, also into the prices of real assets, especially real estate.

The explanations are in retrospect, but what's next?

And now, following the corona crisis, the flow of funds has intensified both on the part of central banks, monetary policy trusts, and on the part of governments, fiscal policy beliefs, and the question arises again: Will inflation remain indifferent this time as well?

Some will say: what was is what will be.

And some will say: this time it is different.

Each of these has strong arguments.

In the meantime, before deciding which of them is right, one can, first of all, try and test what the markets think about it.

There is no need to hold a referendum on this question, as the markets themselves are a daily "referendum".

This is called "inflation expectations": what the markets think the inflation rate will be in the next year, in the next three years, in the next five years and in any period.

By examining current inflation expectations, compared to expectations, for example, at the end of 2019, before the advent of the corona in the US, Europe and also in Israel, one can see where they stood and where they stand today, and in what direction they moved. .

Well, the US inflation expectations have risen in all periods, compared to Germany where they actually declined, and Israel are not really changed, although in recent weeks they are on the rise.

Hence, there is no unequivocal conclusion as to the direction of inflationary expectations, and in any case, their shift is not dramatic.

Do inflationary expectations predict what will happen?

Inflation expectations reflect what markets think about future inflation.

But do they also reflect what will actually happen, that is, are they right?

The answer is no.

Neither in the US nor in Israel.

Is inflation a positive or negative economic phenomenon? What do central banks think of it? It is common to think that moderate inflation, within the limits of up to 2% per year, is positive, as it should encourage households to consume, and in this way contribute to the expansion of economic activity.

households prefer to consume such a situation, as products become more expensive means harm the purchasing power of those consumers - if you prefer to save conservatively, will receive interest close to zero.

therefore it is also no accident that most of the world's central banks set the annual inflation target around their 2%, and in Israel, for example, the target set as a price stability target has for many years been 1% (the lower threshold) to 3% (the upper threshold). Moreover, the US Fed recently announced that it will also suffer from inflation of slightly more than 2%, without it will lead inevitably to raise the interest on his part.

it is also common to think that such a situation far preferable to a situation of falling prices, usually occurs in conditions of economic recession, and reflects deflation, a situation where the value of money is not eroded and therefore consumers do not rush to consume, factories reduce production, laying off workers Workers' purchasing power goes down and back, God forbid. A vicious circle.

Inflation scenario within limits of 2%

It is also better for a situation where inflation is much higher.

The world economic system also knew times when inflation was a terrible hyper-inflation, like in Weimar Republic's Germany on the eve of Nazism's rise to power, or double-digit, like the one in the US in the late 1970s, during President Carter's days. High inflation of about 15% per year, which originated, among other things, in the rising oil prices after the Yom Kippur War, and which also led to very high interest rates, which severely affected the level of economic activity, and of course, the financial markets. -70 in the developed world stood at 10%.

Inflation limits are very clear.

Governor of the Bank of Israel, Prof. Amir Yaron (Photo: Government Press Office)

One of the very hard byproducts of what has been happening in the economic world since the 2008 global crisis, and even more so in the wake of the corona crisis, is the budget deficits of many countries and the dramatic increase in the debt-to-GDP ratio of each country. "Someone" will have to pay this debt.

One way of paying is high inflation, as it is a tax on savings, and it erodes the unlinked debts of countries, and it is also the way of "Machiavellian" governments to erode debts in a planned way, and not necessarily as a result of a natural and uncontrollable inflationary eruption.

So, what do we expect in the coming years? Very low inflation, as it has been in the last decade, or much higher inflation? A result of economic forces, or a result of planning from above? About that, in the next article.

The author is one of the owners of Meitav Dash Investment House, where, among other things, mutual funds are also managed. This should not be construed as a recommendation or substitute for the reader's independent discretion, or an invitation to make a purchase or investment and / or any actions or transactions. Mistakes may occur in the information and market changes may occur

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