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FINANCES | 30.04.2021

Has the ghost of inflation come back to haunt us?

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Since last year, the major world economies have shown signs of a change in price dynamics. The latest signs of rising inflation may end up shaping macroeconomic environments in 2021.

The world economy is experiencing constant changes in growth forecasts. In a context of instability, the uncertainty surrounding the return to normality is continually constraining estimates, and the two-speed recovery of Europe and the US will be determined by doubt as to whether the rise in inflation will be temporary or lasting.

MAPFRE Economics’ report , Economic and Sectoral Panorama, analyzes the rebound in the CPI in economies such as the United States, where inflation in March was 2.5 percent — with an annual forecast of 2.7 percent. This was the result of the Biden government’s stimulus program, the base effect of 2020, which closed with inflation at 1.4 percent, and possibly from the Federal Reserve’s intentions to raise the price level even higher than it is today.

A different scenario is the eurozone, where inflation is approaching 2 percent, and which the study expects to rise to 2.2 percent, considering the extension of mobility restrictions and the adverse effects caused by extraordinary situations such as tax reform in Germany, the effects of Storm Filomena and the increase in the CO2 tax burden.

This upward trend also seems to have reached emerging economies. A few months ago, a new upturn in inflation began to be seen, caused by the de-anchoring of expectations, depreciation of the exchange rate—imported by production prices—and rising oil prices (in countries such as Mexico and Argentina, where they play a fundamental role).

In addition to these indicators, included in the experts’ analysis are others associated with the GDP deflator, which suffered a strong global fall in the last quarter of 2020 (showing that there is no global uniformity in the upward trend in prices) and with real interest rates, which have remained stable during the same period. However, as we have said, the big question is whether this inflationary effect will be temporary or lasting.

 

The increase will be temporary

Recent increases in the CPI have followed the trend of late 2020 in the vast majority of countries, although the data have not yet met the targets set by the major central banks. As explained in the 2018 Outlook report, the Phillips curves remain flat, once again fueling the possibility of secular stagnation.

In view of all this, MAPFRE Economics’ study emphasizes that, given the possibility that these upswings will be only temporary, there are several factors that have constrained price increases. The leading factors among these are the increase in the price of raw materials, the base effect of the decrease in prices during the first wave of infections and the consequences of supply-side restrictions during the pandemic.

In this current situation, the data point to the need to look more at CPI volatility and not so much at the growth trajectory, as it depends excessively on the current context, underpinned by weak demand at a time when there is a significant output gap, savings are not translating into consumption, salaries are falling relative to GDP and the effects of monetary policies are keeping Phillips curves virtually flat.

The increase will be lasting

However, analysts at MAPFRE Economics are looking at the possibility that the rebound in inflation in recent months may continue for longer than we think.

One of the main points to which they refer are the conceptual assumptions that prevailed in recent years and that are now incorrect. Accordingly, that the increase in the price of crude won’t be temporary but rather will follow the trajectory of the last five years; that deflationary pressure in China will cease with the change in the growth model (to one based more on consumption and exports of high-value-added goods), appreciating its currency, and ultimately exporting inflation to other countries; and the link between potential growth and the equilibrium rate will be lost, without any increase in productivity.

The study also notes that there have been changes in the production model, caused by automation and the reshoring of industries to their countries of origin, the increase in externalities and the energy transition.

However, demographic and social changes are other factors that will constrain inflation in the long-term, with high rates of underemployment coexisting with unmet demand for highly skilled workers in new technologies.

The final factor on which prices will depend over time are the effects associated with implicit monetization of the deficit, which will ultimately lead to increases in inflation and inflation expectations.

It is clear that the duration of this trend will be decisive in terms of how the various macroeconomic scenarios play out at the global level in the next few months.