The return of inflation ?

07.09.2021 3 min
Find the complete version of my column published in the issue of Les Echos of July 26, 2021.

The post-pandemic period is triggering a strong rebound, and it will take time for supply chains to recover and supply to adjust. As a result, most economists believe that inflation will only be temporary. Moreover, structural reasons for very low inflation persist. In fact, inflation is curbed by globalisation, which keeps the prices of labour, goods and services contained, and the technological revolution, which reduces the bargaining power of low-skilled employees and which, through the dissemination of digital technology and robotisation, allows for productivity gains. It should be noted that since the 1980s, there has been a decorrelation between monetary growth and inflation. And since the 1990s, the Phillips curve has nearly disappeared, as a rise in employment no longer leads to price growth. But what are the reasons that the rise in inflation could be sustainable? 

If we look at the long history since the 19th century, we have been experiencing long cycles of inflationary regimes, where the economy is dominated by monetary policy, which fights inflation by dragging down growth when inflation accelerates too much, and vice versa. We also observe alternating long cycles of low inflation, due to the effects of globalisation and technological revolutions. Such a low inflation cycle was in effect at the end of the 19th and start of the 20th centuries, as in the past thirty years. The current cycle has already lasted for a very long time. This is not a sufficient reason to believe that it will end, but this is a cause for reflection. Today, by removing the lid on the economy during the pandemic and with very strong support and then stimulus policies, prices are rising. And the risk of returning to an inflationary cycle re-emerges, a risk that we have not experienced for a long time.

If the pandemic does not lead to “the world after”, it has significantly accelerated the changes that were already under way. In the United States, but also in Europe, there are labour shortages in many sectors, including in low-qualified services, even though overall employment has not returned to its previous trough. As a result, wages are increasing significantly at McDonald’s and in high value-added companies to attract new employees and retain them. Macroeconomic analysis can give false indications if it only focuses on aggregate figures. Let’s add that Biden rightly wants to increase low wages. But the pace and intensity of these increases will be critical. In addition, in most OECD countries over the past few decades, real wages have risen below productivity gains, which is a deformation of the value-added sharing process, to the detriment of employees. Thus contributing to populist reactions and leading to possible future demands, sooner rather than later, for higher wage growth.

With the developments of history in the background and the major economic and employment changes in progress, the sharp rebound in the economy and the resulting significant rise in prices could, if necessary, and if the pandemic does not resurface, trigger a new indexation of wages to prices, and then an indexation loop that could lead the world into a new inflationary cycle. The growing cost of the necessary energy transition may also weigh on a sustained rise in prices. Nothing is certain, far from it, but the scenario should no longer be ruled out.

However, we wager that the central banks, thereby demonstrating their independence vis-à-vis governments and financial markets, would act when growth returns to its medium-term trend to stop such a return to an inflationary cycle. The resulting rises in interest rates would be welcome to curb the speculative bubbles that are currently forming. But governments or companies that are highly indebted should prepare as best as they can by taking structural action on their solvency trajectory.

Olivier Klein
Chief Executive Officer of BRED - Professor of Economics and Bank Management, Financial Macroeconomics and Monetary Policy at HEC