The Federal Reserve and other central banks across the globe have been trying—and failing—to generate higher inflation for more than a decade. Inflation is generally viewed as a sign of a growing economy. While other indicators rose in recent years, the inflation rate hasn’t gone up accordingly and the banks have tried any number of strategies to spark it.
However, all the pieces are in place now to that we could start to see the type of inflation that the Federal Reserve has been after for decades. Experts predict we could experience significant inflation in the next few years. Of course, right now the trends are very low because of the COVID-19 pandemic and its devastating effects on the U.S. economy, but economists on Wall Street always have their eyes on future economic trends.
The Forces Are Aligning
Between the economic stimulus efforts that are providing unprecedented fiscal support, a growing national debt and recoil against economic inequality, the factors are ripe for substantial inflation in the coming years.
“The forces that bring about inflation are aligning,” says Chetan Ahya, who is chief economist at Morgan Stanley. “We see the threat of inflation emerging from 2022 and think that inflation will be higher and overshoot the central banks’ targets in this cycle. This poses a new risk to the business cycle, and future expansions could also be shorter.”
2% is the target inflation rate that has been set by the Fed. Economists consider this a reasonable level that would indicate a healthy, growing economy with a strong standard of living. What Ahya sees is the real potential that we could see even higher inflation rates in the United States because of the what he calls the “3 Ts:”
Short-Term Solutions vs. Long-Term Effects
Right now, low levels of inflation are expected in the very near future as social distancing rules and other COVID-19 concerns will hinder a majority of industries’ ability to operate with normal production and profitability. Where it gets tricky is how the policymakers and banks have responded to (and will continue to respond to) this economic downturn.
“Taken together, the policy actions … are more likely than not to result in a significant distortion of underlying productivity growth trends,” adds Ahya. “Hence, we view the threat of inflation returning this cycle as a serious one. It could transition in to a malign form of inflation, especially if significant disruption to the 2 Ts creates a regime shift in the outlook for corporate profitability.”
The other factor worth looking at is the national debt. Just recently, we went over the $25 trillion mark for the first time in U.S. history and it will only go up as the government commits more money to economic recovery and public health efforts. This could cause the Fed to enact more pro-inflation policies to make the debt cheaper in the short term. Over the long term, though, it could shoot the inflation rate significantly upward as the economy eventually recovers. This could eventually lead to higher interest rates and more expensive financing costs.
Meanwhile, other economists see it differently. Aneta Markowska sees these inflation concerns as “overblown” at a time when there are other financial issues that need to be dealt with in the wake of a COVID-19 economy.
“Supply chain disruptions may cause price spikes in certain products,” Markowska says, “but in the face of constrained incomes, this would only lead to demand destruction and become self-limiting.”
It’s an interesting topic for sure. Everyone is being forced to react based on what’s happening because of coronavirus and it’s hard to fully predict the future when the present is so overwhelming. Only time will tell how any short-term relief solutions implemented now will affect our economy in the long run.