Steven Joyce: Covid stimulus party risks waking inflationary bear


As vaccines begin to work their magic big economic policy questions are starting to be asked around the world.

Are we all guilty of poking the inflationary bear? And what happens if it wakes up? Will the imbalances caused by the gargantuan economic response to Covid-19 create bigger problems than those caused by the pandemic itself?

Economists’ views on what happens next mostly depend on their views about inflation.

The doves believe it is completely dead. As far as they’re concerned inflation was slayed in the 1990s, and thanks to the competitive impacts of globalisation and the digital revolution, it isn’t coming back.

For these economists there seems no level of money printing or fiscal pump-priming that is too large to bring the world economy back to life. With no inflationary price to pay, the world should go hard and then go hard again.

Wages too can be legislated up without consequence, and the old theory of inflation being the result of too much money chasing too few goods is, to them, debunked and discredited. This is the new world of free money and no economic consequences.


The hawks on the other hand are starting to get worried. They see the sheer volume of stimulus, the resulting rich-world government debt, and all the money printing as entering uncharted territory. They see near-zero interest rates creating huge asset price bubbles, be it in housing, shares or bitcoin.

They see everybody chasing yield and forgetting risk. And they also see massive volumes of money in circulation and the early signs of an inflationary spike that could tear the whole edifice down.

If inflation does reappear, and central banks are obliged to move to choke it off, then even modest increases in interest rates could play havoc with asset prices and government debt and cause major economic disruption.

The doves take comfort from what happened after the global financial crisis. The large stimulus packages then did not result in inflation.

The hawks point out that the size of today’s stimulus party makes the GFC response look like a church picnic.

They also point to events like the 2013 taper tantrum in the US as evidence of how vulnerable asset markets are to even a moderate tightening of monetary policy.

The outlook for inflation is looking less benign this time. The structural shifts that helped create a low inflationary environment are waning.

Globalisation is accused of many things but it was a huge boon in providing lower prices for consumers all over the world. It is now in retreat as geopolitics takes a darker turn.

Goods prices are rising as a result of post-Covid freight snarl-ups and many commodity prices, including milk and oil, have recovered much more quickly than people expected.

Here in New Zealand, other inflationary pressures are also starting to appear.

Housing and construction costs are increasing. New regulatory requirements are pushing up rents, and councils are proposing double-digit rates increases for the first time in decades. The Government is stoking things along in a number of ways, including by deliberately restricting the labour market with its border controls and pushing up minimum wages and public sector wages aggressively, without any commensurate increases in productivity.

Government energy policy in the name of the environment will boost energy and transport prices, while green tape is pushing up the cost of food production. These policy calls may or may not have merit, but all are further pokes at the inflationary bear.

The biggest poke of all is the one currently being orchestrated in the US by new President Joe Biden. Unimpressed with the two giant stimulus packages Congress has already passed, he is instigating the mother of all stimulus plans, just as the pandemic peaks, estimated to be worth an unbelievable 10 per cent of the entire US economy.

It’s so big even Larry Summers, Obama’s loyal economic guru, has baulked at it. This giant economic experiment could, and will likely, have worldwide inflationary repercussions.

The resurgence of world inflation is by no means a slam dunk. There are countervailing pressures, including the possibility that the world economy is sicker than it currently appears. If it is really sick, then maybe this sort of foot-to-the-floor stimulus is needed, but that would hardly be good news. Instead the policy response increasingly begins to feel like an overreaction.

Perhaps we have all underestimated how much a pandemic recession represents a temporary depressing of demand, rather than a permanent impairment of collective wealth.

Some inflationary pressures will be one-offs. Central banks are promising to “look through” short-term inflationary spikes and, for the first time, calibrate their responses by averaging inflation rates over a longer period than in the past.

Given many have previously loudly declared they won’t be lifting interest rates for years, that looks a tad convenient, and also risky. Once inflationary expectations take hold, they are hard to break.

So what’s the harm with inflation? How bad could it be? For those of us too young to remember, inflation eats away at people’s purchasing power and effectively reduces incomes. It raises the cost of living and interest rates. It’s like a tax on your future, to pay for the economic stimulus we are enjoying now. And it’s hardest on people with low incomes.

Even worse the reappearance of inflation could puncture our over-inflated asset prices. And that would make everyone feel poorer, causing a rapid economic slowdown.

New Zealand doesn’t yet have an inflationary problem. The last two quarters suggest we are tracking around the Reserve Bank’s inflation target of 2 per cent. But the risks are mostly to the downside.

And there is plenty of evidence that inflation isn’t dead. Developing nations like Turkey, India, Pakistan, Argentina and much of Africa are grappling with it as we speak. In the Western world it is likely just sleeping. Best we don’t poke it too much and wake it up.

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