Guest contribution by Ewald Nowotny - Inflation perspectives in conflict of opinions

The much-quoted sentence comes from the great Austrian playwright Johann Nestroy: "The Phoenicians invented money - but why so little?" However, there is no consensus on the question of which inflationary effects can be expected from this perspective.

There are a number of recognized economists who expect inflation rates to rise significantly over the medium term, especially for the United States. The most important line of argument relates to the connection between an extraordinarily expansive financial policy and an equally expansive monetary policy. In the medium term, this would lead to an overutilization of the available resources of an economy - and thus to corresponding price increases. In the short term, the expansionary financial policy prevented incomes from falling during the crisis. Of course, a considerable part of this disposable income was used for higher savings.

This is seen as a - admittedly strongly weakened - constellation analogous to times after the wars, where with "normalization" the reduction of the accumulated savings meets a limited supply of goods - with corresponding inflationary effects. Adjustment delays and earlier investment declines in the course of economic normalization can also lead to bottlenecks. This is currently evident in the spectacular price increases for individual preliminary products and in ship transport. With different adjustment times, however, these price increases will again lead to an increase in the range and thus to a "normalization" of the price development.

A longer-term oriented argument relates to geopolitical developments, which could lead to a decline in the extent of economic globalization. This would remove the driving force behind inflation in the past few decades. Another long-term perspective concerns demographic development. This will lead to a shortage of qualified workers, especially in the highly developed countries of Europe. This will again strengthen the bargaining power of the trade unions, which has been weakened by globalization. Correspondingly higher wage agreements would, at least in part, lead to higher prices. Of course, there are also opposing perspectives of the effects of increasing automation.

Significant price surge can be explained by special effects

Finally, the growing weight of environmentally oriented steering taxes, especially CO2- Taxes prove to be an element of cost inflation - comparable to an "oil shock on installments". It is true that the negative social effects can (perhaps) be compensated by counteracting relief. The price effect - which is desirable in the case of incentive taxes - will in any case exist.

The strategic perspective is more difficult for the ECB, since the single monetary policy is not opposed to a single financial policy. - © afp / Armando Babani
The strategic perspective is more difficult for the ECB, since the single monetary policy is not opposed to a single financial policy. - © afp / Armando Babani

From the point of view of a “monetarist economy”, reference is made to the massive increase in the money supply by the central banks. In the US, for example, the M4 money supply rose by 2021 percent in the first quarter of 25 compared to the same quarter of the previous year. A significant price surge is expected from this development with a delay of around two years. It is true that there has been no reliable connection between the development of the money supply and inflation in recent years. With a "normalization" of the economic situation, however, the velocity of money would increase again and with it the inflation potential.

As a counter-position to fears of inflation, it is argued that - unlike after the war - the decline in production caused by the pandemic was due to health policy and was therefore temporary. As shown, bottlenecks can lead to price increases. For central banks with a longer-term orientation, however, there is no need to react to temporary price increases.

In addition, the significant price increases in this year can be explained by special effects (for example the end of the VAT reduction in Germany) or by base effects related to extremely low prices in the previous year. This applies especially to the oil price, which is important for the development of inflation. There were extremely low prices here in the previous year due to the crisis. The enormous price increases in this year therefore only represent a return to a “normal” price level. That means a distinction must be made between changes and the level of goods prices. Likewise, the relationship between the money supply and price developments in a modern globalized economy will be masked by a host of other external factors.

Fed is ready to "let the economy run hot"

Of particular importance, however, is a fundamentally new development in the economic perspective. A large number of empirical studies show that the production potential of an economy is much more flexible than previously assumed. Specifically, a considerable part of the unemployment previously seen as “structural”, i.e. independent of the economic cycle, is actually caused by the economic cycle. Likewise, the potential workforce has been underestimated by not considering “hidden unemployment”.

Financial and monetary policy have been too restrictive for unfounded fear of inflationary developments. And even if there should be a slight increase in inflation rates, US economic policy is now ready, as the chairman of the US Federal Reserve put it, "to let the economy run hot". Due to the corresponding massive demand pressure, it should also be made easier for previously disadvantaged population groups and regions to integrate into the labor market.

Ewald Nowotny (77) was Governor of the Oesterreichische Nationalbank from 2008 to 2019 and thus also a member of the Council of the European Central Bank. Before that he was General Director of Bawag PSK from 2006 to the end of 2007. From 1978 to 1999 he was a member of the SPÖ's National Council and from 1990 to 1999 a member of the SPÖ's federal party executive. - © photonews.at / Georges Schneider
Ewald Nowotny (77) was Governor of the Oesterreichische Nationalbank from 2008 to 2019 and thus also a member of the Council of the European Central Bank. Before that he was General Director of Bawag PSK from 2006 to the end of 2007. From 1978 to 1999 he was a member of the SPÖ's National Council and from 1990 to 1999 a member of the SPÖ's federal party executive. - © photonews.at / Georges Schneider

Political aspects are also connected with this. The current US administration assumes that economic policy was already too restrictive under the influence of the advisers to ex-President Barack Obama, which contributed to the emergence of those frustrated sections of the population on which his successor Donald Trump could then rely to a large extent. In concrete terms, this means that fiscal policy will continue to be highly expansive, while accepting considerable budget deficits. And it also means an expansive monetary policy that is prepared to compensate for the past fall below the price stability target of 2 percent in the form of the strategy of "inflation averaging" by allowing it to be exceeded in the future.

The politics of the USA is of course also of importance for Europe. However, in Europe there is less need to let the economy “overheat” in order to alleviate the labor market problems of disadvantaged groups due to the much better developed welfare state and especially through measures of the "active labor market policy" which does not exist in the USA.

On the other hand, the economic crisis caused by the pandemic had a much stronger impact in Europe than in the USA, which also led to a more pronounced fall in inflation rates. The inflation rate in the euro area has remained a total of 2007 percentage points below the price stability limit of 10 percent since 2. The current forecasts of the European Central Bank (ECB) and the Oesterreichische Nationalbank (OeNB) also assume that, after a slight increase in 2021, there will be comparatively low inflation rates again in the following years (inflation rates 2022: euro zone 1,5 percent, Austria 1,8 , XNUMX percent).

Caution should be exercised in the “normalization” of ECB policy

Overall, with regard to inflation developments, a very clear distinction must be made between the short, medium and long term. In the short term, i.e. over a period of around two years, once the special effects have expired, a decline in inflation in the direction of the central banks' stability target is to be expected. In the medium term, i.e. for a period of around two to five years, there can be a risk of overutilizing resources, especially in the USA. The US Federal Reserve is therefore already beginning to consider cautiously curtailing its expansionary monetary policy. It will probably give further pointers in this direction at the big central bank meeting in the idyllic Jackson Hole this August.

 

 

 

For the euro area, the strategic perspective is more difficult, since the single monetary policy is not offset by a single financial policy. The more quickly the individual states pursue a policy of budget consolidation, the more cautiously the ECB must proceed in the interests of the economic stability of the euro zone in “normalizing” its policy. In any case, the trend towards low inflation leaves it room for maneuver.

As has been shown, there are a number of - often contradicting - perspectives with regard to long-term inflation developments. For certain periods of time, slightly higher inflation rates would of course not be a new constellation, even for “normal times” in European economic history. For example, supply-side shocks such as the oil crisis led to severe inflationary spikes at times, often with longer-term effects.

Even for the dominant D-Mark during its existence - 1950 to 1998 - the average annual price increase rate was 2,8 percent. In Austria, too, phases of higher and lower inflation rates alternated. With higher inflation rates there is undoubtedly a need for action and adjustment on the part of the central banks, politicians and the private sector. In any case, what can be ruled out in politically stable, “normal” times is a reversal of “normal”, politically controllable price increases into a “galloping” hyperinflation, which always occurs as a direct and indirect consequence of warlike developments. •