Page 15 - ISQ July 2021

JULY 2021

Q: Does much of the debate about inflation surround a possible was intended to act as income replacement due to pandem-
central bank policy response? ic-induced shutdown, yet now it is well known that these
amounts have been far greater than what might have otherwise
A: This is clearly a hugely important point for investors in finan- been received in wages. This has resulted in the flood of
cial assets. What should be highlighted from the outset is spending underlying the global economy’s rapid recovery. At
central bankers’ obsession with trying to evolve a (developed) the same time, enforced business shutdown has forced the
economy that produces inflation at an average annual rate of manufacture and distribution of many items to be disrupted,
2%. What is extraordinary about this target is how it was calcu- notably silicon chips, essential in the smooth evolution of an
lated or deemed to be appropriate. Despite volumes of erudite economic cycle. The outcome is lower supply smacking straight
journals, millions of hours of lectures and armies of PhDs all into higher demand for goods and services. The result is rising
working assiduously on the matter, the 2% dropping out of the prices and apparent inflation.
end of the pipe is, in fact, a number created out of thin air. Is it
appropriate that policy settings be adjusted simply on the Q: If that is right, then the inevitable conclusion to this episode
basis that inflationary pressure has, perhaps temporarily as must be that once supply and demand are back in equilibrium
central bankers tell us, overshot this arbitrary line in the sand? the inflation we are seeing should subside?
Q: Why hasn’t inflation been booming for years? A: Exactly! The combination of more and more businesses reo-
pening should, in time, result in a return to pre-pandemic
A: Other than the above reasons, since the bursting of the tech supply. Furthermore, once government support for businesses
bubble developed economies have operated through 15 of 21 and households concludes, demand should very likely retreat
years with interest rates near zero, whilst also having central from today’s elevated levels. This should have the effect of
banks implement quantitative easing. Yet during those same driving prices lower.
years underlying CPI (excluding food and energy) has exceeded
the magical 2% threshold in only three of them in the U.S. and CONCLUSION
never in Japan or the Eurozone. Monetarists might argue that,
even at or close to zero (and negative in Japan and the Euro- Firstly, central bank monetary policy is not creating inflation. Sec-
zone) interest rates were simply not cut enough and not enough ondly, fiscal policy and especially government handouts are
electronic money was printed! In fact, the opposite to that which creating inflation. Thirdly, global shutdowns one year ago are cre-
was thought necessary has occurred. Instead of historic stim- ating easy comparatives, but these “base effects” will diminish over
ulus resulting in a spending splurge, ever larger amounts of time. Fourthly, shutdowns have created supply disruptions which,
private capital has decided not to participate in the real economy unless becoming permanent, will diminish as supply comes back
but been parked elsewhere. The velocity of money has col- on line. Fifthly, and lastly, central banks must set policy not for the
lapsed and financial asset prices have sky-rocketed. here and now but for the months ahead. They must also play their
part in minimising medium or longer term economic risk. If activity
Quantitative easing is a deliberate, if indirect, means by which levels dwindle as fiscal stimulus is withdrawn (to be replaced by
central banks suppress interest rates for as long as possible. In so fiscal tightening), ultra-accommodative monetary policy must act
doing, central banks are effectively funding mountainous (and as the counter-weight. The bigger risk is not transient inflation now,
rising) government budget deficits and debt rollovers, essential but sustained economic weakness in the future.
if countries are not to default. Yet all these newly created reserves
are simply clogging up the banking system and are not being
released by new loans or credit creation. It is this “clogged up” KEY TAKEAWAYS:
part of the QE process that suggests that the apparent rise in • Central bank monetary policy is not creating inflation.
inflation we are now seeing is not really occurring due to mone- • Fiscal policy and especially government handouts are
tary policy. creating inflation.
Q: So, if not monetary policy then what? • Global shutdowns one year ago are creating easy
comparatives but “base effects” will diminish over
A: We need to look at the “other side” of economic theory, in short-
hand “Keynesian” or fiscal policy. Specifically, this refers to the time.
fact that across developed economies, to a lesser or greater • Central banks must set policy for the months ahead.
extent, many businesses and households have either directly or • The bigger risk is not transient inflation now, but sus-
indirectly received payment from the government. Initially this
tained economic weakness in the future.

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