The events of 2020 and so far in 2021 have provided quite a shock to the economic system. Let us call it what it has been which is a depression. It may for some be a speeded up one but others such as Italy and especially Greece had never really recovered from the credit crunch one so it is another feature in their lost decade. The policy response and the hoped for bounce back pose a lot of questions? Today I intend to look at the inflation issue.
Where Does It Come From?
Both versions of economic policy have been applied with full force. If we start with monetary policy we see a world of ZIRP ( Zero Interest-Rate Policy) and in some places NITP ( N = Negative) plus a whole swathe of bond and asset buying under the QE banner. This has meant that the money supply has surged. For example on the UK the measure of broad money M4 is growing at an annual rate of 15%. Monetarist theory suggests that goes into nominal GDP and as growth will not be 15% there will be an inflationary push. With the swings in the economy it is hard to have any precision as where do you start from?
Another way of expressing the problem is shown by the US. Right in the middle of the crisis ( last May) they changed the definition of the M1 measure of the money supply and roughly trebled it. So analysis is broken for it and we see a classic bureaucratic move. So they are worried and the first response is to try to hide the evidence.
If we switch to fiscal policy we see that the taps have been open there too. For example the Chancellor claimed this in his Budget Speech yesterday.
Once you include the measures announced at Spring Budget last year, including the step change in capital investment, total fiscal support from this Government over this year and next amounts to £407 billion.
Let me give you the US position from a different perspective.
US National Debt moves above $28 trillion for the first time, increasing $4.6 trillion over the last year. ( Charlie Biello on Tuesday)
I note that the discussion seems to be bypassing $29 trillion and going straight to $30 trillion as people mull the stimulus plan of President Biden.
Savings
These are another reflection of the situation and bring in elements of both factors above. Let me explain via the US which updated us at the end of last month.
Disposable personal income (DPI) increased $1,963.2 billion (11.4 percent) and personal consumption expenditures (PCE) increased $340.9 billion (2.4 percent). ( BEA)
As you can see there is quite a gap and a heavy hint at quite a surge in savings. This was backed up later.
Personal saving was $3.93 trillion in January and the personal saving rate—personal saving as a percentage of disposable personal income—was 20.5 percent
So there has been an over US $3 trillion rise in savings and the January rise came from fiscal policy.
The increase in personal income in January was more than accounted for by an increase in government social benefits to persons as payments were made to individuals from federal COVID-19 pandemic response programs.
Switching to the money supply this will be part of the increase in it ( strictly speaking the amount which is now sitting in bank accounts).
If we look at monetarist theory this is quite close to how the textbooks explain it. The phrase “excess money balances” covers savings which are mostly being built up because they cannot be spent. In the theory the next step is that when they are spent we get growth but also inflation.
Inflation Expectations
These are in my opinion widely misunderstood. Just because there is a price for something does not mean it is the right price and these days so many prices have been manipulated by central banks. The first situation is like forward prices for exchange-rates which are far from a guide to future exchange-rates and are a reflection of now rather than the (unknown) future. Here is Kailey Leinz of Bloomberg.
Hello inflation expectations. 5-year breakevens just hit 2.5% for the first time since 2008.
As Dawn Penn put it “No! No! No!”. There is an implication of more inflation but as a measure it is very inaccurate. That is before we get to the next issue which is that the US index or inflation linked bond market has been rigged by a familiar player. It has bought some US $321 billion of them or if you include the inflation compensation US $365 billion of them.
The concept was given a push by the ECB back in the day but it all backfired and went wrong, But as so often these days this sort of thing survives.
Output Gap
Whilst we are discussing things which are useless let me point out one more time that the Output Gap concept has had a dreadful credit crunch era. If economics was a science then its continual failure would lead to its rejection. Even worse it is dreadfully measured yet some cling to it like a life raft. My advice is to avoid it.
Inflation Measurement
This is an issue and let me be clear even a genuine attempt at inflation measurement will not be perfect. It will be a generic but it can be genuine unlike the official measures I see. The first issue comes from owner-occupied housing and the worst case is the Euro area which completely ignores it.
House prices up by 4.9% in the euro area (EA-19) and by 5.2% in the EU-27 in the third quarter of 2020, compared with the same quarter of 2019. ( Eurostat)
Other countries ( US and UK ) use rents as a way of reducing inflation and the UK is so desperate it uses last years rents. As an aside that is backfiring right now. But the crucial point is that in the US house price inflation of 9%-10% becomes the much more friendly 2.7% of imputed fantasy rents.
Next comes the impact of the pandemic itself and the shift in our spending patterns. I asked the UK Office for National Statistics about spending on masks and cleaning products. I was told it was not significant. I did not believe that then and even less so now as mask use has increased. For a cost of living measure the whole change is an increase. Another area has been the increase in the number of people get dogs leading to a doubling and trebling of the price. Apparently it is too hard to get a price which us news to the two people I know who have got one in the last fortnight.
Comment
There has been a fair bit of debate on this issue on social media. Some of it has been from those who previously assured us there would be no inflation so there has been an element of covering their tracks to some extent. But let me get to the heart of the issue which is can you have deflation and inflation at once? The answer is yes mostly because deflation ( a fall in aggregate demand) is misunderstood. Looked at like that it not only has been here for a year or so it will be for at best some months yet. We already have inflation if you look at the US January numbers.
Real PCE increased 2.0 percent; goods increased 5.1 percent and services increased 0.5 percent
As depending where you are some or many services are not available if you start adjusting for reality you move nearer to the 5.1% of goods inflation. Add in house price inflation and you can see where this is going.
Also it does not need much inflation these days to cause trouble because wage growth is weak. So even the 3-4% that central bankers currently dream of can cause quite a downturn for the ordinary person. In the UK if we look back to 2010/11 we see that real wages have never recovered from the 5% inflation peak back then. Oh and back then I made similar points to today against a background of claims that we would either have no inflation or hyper inflation.
For the avoidance of doubt I have reported the latest UK average earnings figures as not fit for purpose to the UK Statistics Authority.