Vijay Kumar Gaba

In past few weeks we have seen some very interesting debates over the prospects of inflation forcing central bankers to change the course of ultra-loose monetary policy and thus derailing the global recovery. There have been strong arguments on both the sides. However, the debate seems to be still inconclusive. There are many reasons for strong disagreements. For one, the debate suffers from historical prejudices and does not completely factors in the fast changing demographic and technological factors. It may also not be fully accounting for the fast evolving sustainability concerns and consequent changes in the global trade and commerce.

Nonetheless, I still find it pertinent to take note of divergent views on the expected trajectory of inflation. Recently, two reputable experts Martin Wolf (Financial Times) and David Rosenberg (Rosenberg Research) published their views on inflation expectations. Both the experts are widely recognized for their biases, and these mutually divergent views do suffer from these biases. Regardless, these views are significantly educating and worth taking note of.

David Rosenberg

The argument that Money supply against money velocity is not leading right now to an inflationary conclusion may not be well founded. Look at wages. Look at all these companies announcing wage increases. After Trump cut taxes on the corporate side and allowed companies to repatriate tax free their earnings from abroad back home and all these companies, 4% of the corporate sector announced wage and bonus increases back in early 2018, some bellwether companies too. So where was the big inflation coming out of that?

Rosenberg essentially agrees with Fed Chairman Jerome Powell that the recent acceleration in inflation seen in April will be temporary. He opines that “What's going on isn't a fundamental "regime shift", but rather a "pendulum" swinging back to the opposite extreme following the sudden deflationary demand shock caused by the pandemic.”

The factors that contributed to this surge in prices are already starting to fade. Commodity prices are falling back to earth, supply chain shortages are slowly being addressed, and leading indicators already show a dramatic increase in exports out of Korea and Taiwan, critical sources of semiconductors. Meanwhile, container ships that are "filled to the brim" are lingering outside the ports of LA and Long Beach, the two busiest ports in the country, as COVID concerns continue to delay the unloading of these ships. With all these signs that supply chain snarls are quickly being worked out, to suggest that the supply will not come back to me is ridiculous.

On the demand side of the equation, federal stimulus has created a sugar high that will wear off by the fall. Around that time, all the workers being kept out of the labor pool by generous government benefits will be forced to look for work again, and the "fiscal withdrawal" will emerge to suppress aggregate demand just as supply levels are normalizing. The fiscal policy and the short term nature of the stimulus has just accentuated the volatility in the data. So, come the fall, we will start to see the re-openings having a positive impact on aggregate supply at a time when we shall see fiscal withdrawal having a downward impact on demand. And so a lot of the inflation seen today is going to reverse course either by late summer or early fall.

Last week, data indicated that productivity is running over a 4% annual rate. Not clear if it is a secular or structural change. But one thing is clear that in the weakest year for the US economy since 1946, it was the best year for productivity in a decade. The corporate sector actually had its best productivity performance in a decade in the same year that we had the worst year for employment since the 1930s.

The TIPS market shows that most inflation expectations being priced in are still "very near term", and that spreads between twos and fives, fives and tens, and twos and 30s shows there's been "no big outbreak of longer term inflation expectations.

They're just telling you that right now we have a tremendous dislocation. And yes, it's going to probably gonna last a few more months. It's not just your base effects. There is some real price increases coming into the fore. But what would you expect? We just had a 10% increase in airfares and the CPI index, they're still down 20% from where they were pre-COVID. You know, the sports tickets and the like that were up 10% in April. You know they're down significantly for where they were pre-COVID. And so there's still tremendous amount of distortions.

(With inputs from www.zerohedge.com . Read the full interview of David Rosenberg here)

Martin Wolf

Milton Friedman said that “inflation is always and everywhere a monetary phenomenon”. This is wrong: inflation is always and everywhere a political phenomenon. The question is whether societies want low inflation. It is reasonable to doubt this today. It is also reasonable to doubt whether the disinflationary forces of the past three decades are now at work so strongly. It is hard to believe these emergency monetary policies should continue for years, as many at the Fed think. I doubt whether they should continue even now.

The jump in US annual consumer price inflation to 4.2 per cent reported last week was a shock. But was it a good reason to panic?

Goldman Sachs notes that the proximate causes of that jump lie in travel and related services, where prices are rebounding from depressed levels, and in some goods, where a post-pandemic surge in demand has run into temporary shortages and bottlenecks.

The Commodity prices have jumped upwards. But prices are not that high by historical standards and are well below past peaks.

Meanwhile, the “break-even rate” — the difference between the yield on conventional and inflation-indexed US Treasuries — has risen sharply, though still to only 2.5 per cent over 10 years. This indicates a rise in inflation expectations and concern over the risks of inflation. Bloomberg’s John Authers notes that forecasts by consumers and professional forecasters have also risen, with the former expecting close to 6 per cent inflation and the latter 3 per cent over the next year.

Both monetary and fiscal policy settings are, by historical standards, wildly expansionary, with near-zero interest rates, exceptional monetary growth and huge fiscal deficits, even though the IMF suggests that the US economy will be operating above potential this year.

There is a large overhang of private savings waiting to be spent and surely a great desire to get back to normal life. Maybe, these will not be the “roaring 2020s”. But they might be far more economically dynamic than most suppose.

While I understand why the Fed changed its monetary framework, I am unpersuaded it was a good idea. It means driving while looking into the rear-view mirror. It would surely be better to learn from past experience how the economy works than to try to compensate directly for historic failures. In particular, the new framework creates uncertainty over how the Fed intends to make up for the past shortfalls.

The politics have changed. One would have to be at least 60 years old to have experienced high inflation and subsequent disinflation as an adult. The government and substantial swaths of the private sector have huge debt liabilities and borrowing plans. Joe Biden’s administration is determined to ensure that this recovery does not repeat the disappointment of the previous one. The stock market is more than generously priced by historical standards, with bubble phenomena everywhere. The doctrines of “modern monetary theory” are highly influential, as well. All this together has strengthened lobbies for cheap money and big fiscal deficits, and weakened ones for prudence.

Given all this, doubts about the Fed are reasonable. We know that it is politically easier to loosen than tighten monetary policy. Right now, the latter is going to be particularly unpopular. Yet if a central bank does not take away the punch bowl before the party gets going, it has to take it away from people who have become addicted to it. That is painful: it takes a Paul Volcker.

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