Inflation could help to stave off a post-Covid economic depression

I sympathise with Brian Griffiths’s concern for the inflationary outlook in the wake of Covid-19 and the dramatic policy interventions it has provoked. I well remember that my father elected to retire early in February 1974 to play more golf, only to watch the real value of his final salary pension cut in half over the following two years. This sense of shock, disappointment and unfairness was replicated for millions of retirees at that time. Those with still-vivid memories of the chaos of the 1970s remember well that high unemployment and high inflation rates can co-exist.

Regarding Jim O’Neill’s response, it is true that the monetarist proposition — that inflation is always determined by the amount of money in the system — is commonly regarded as simplistic and inadequate. Over the past 30 years, the capital markets revolution has weaponised government borrowing. Savers and investors were tempted out of bank deposits into higher yielding bonds as returns improved, and back into deposits as returns declined. The growth of bank deposits drove the value of financial asset prices, but not inflation.

However, the Financial Conditions Index (FCI) that Jim O’Neill proposes has its own problems as an indicator, for the very reason that it captures financial market prices. As central banks measure their own performance in terms of financial market outcomes and indulge in price manipulation in financial markets, then the FCI falls victim to a variant of Goodhart’s law: “When a measure becomes a target, it ceases to be a good measure”. Whatever the historical usefulness of FCI as an indicator, in current circumstances it is unreliable.

Targetting nominal GDP growth, a measure that combines both real economic activity and inflation, in preference to simply inflation, supposes that we have more control over GDP than CPI. Again, in current circumstances, this is difficult to sustain. Since the Great Financial Crisis, neither zero interest rates nor quantitative easing has proved effective in stimulating the growth of incomes.

There are two further points to consider. First, I take issue with the underlying premise that macro management over the past 30 years has been consistent with price stability, even though inflation has been subdued generally. The accumulation of debts by households, businesses, financial entities and the government has squeezed the life out of conventional monetary policy. Our debt-laden economies can no longer bear interest rate increases, or so our central bankers have come to believe. The “walking dead” among our households and businesses are mirrored by zombie central banks.

In many advanced economies, we have reached the point where there is little hope that more debt will induce more economic activity. What is required is some form of moratorium on the existing burden of debt. Unless inflationary forces are unleashed as a safety valve, we risk a devastating depression which could well de-stabilise civil society. From this perspective, we are ripe for a monetary reset and only when it has occurred will it be feasible to put new policy structures in place.

Second, we should at least consider the idea that a post-Covid inflationary backlash is already upon us. The near-term inflation outlook is highly uncertain because we have three powerful forces at work: the strength of the recovery in private sector spending, the impact of furlough payments and other government relief measures, and the extent to which economic capacity and output is curtailed by post-Covid-19 restrictions.

There is emerging evidence that consumers’ experience of inflation during lockdown has been very different from the message of the published inflation figures. Using scanner data covering millions of transactions for fast-moving consumer goods, research has shown that UK inflation in the first month of lockdown was 10 times higher than in preceding months, as discounts and promotions were withdrawn and product choice was restricted. Inflation may be spiking already.

Not only should we take the spectre of inflation much more seriously, but we should also acknowledge that our macro-financial policy framework has been fraught with inconsistencies over many years, and especially since the financial crisis. The long hard battle to drive inflation out of the system 40 years ago may need to be fought all over again.