This is a column by BNR’s in-house economist, Han de Jong.
However, one important difference with 2008/2009 has escaped all those economists. Due to the lockdowns, large numbers of people have been unable to work, including in the manufacturing industry. Therefore, the production capacity has actually been reduced in the short term. The demand for goods, on the other hand, has increased as politicians have massively supported jobs and incomes and people have been forced to change their consumption patterns from services to goods.
Economists should be ashamed of themselves
Indeed, economists should be ashamed of themselves. In the first lesson that follows, the laws of supply and demand are explained. If supply decreases and demand increases, the price will increase. By the way, you don’t even need to take a course to understand this, but for most economists it turned out to be too complicated.
Lesson two was also apparently in vain
The second lesson of the economics course explains to aspiring economists that a rapidly growing money supply can contribute to inflation. While the money supply grew dramatically due to aggressive central bank policy at the time and thus served as fuel for the inflation fire, most economists called for inflation to disappear on its own. So even that second beginner lesson was not spent on all those economists. “The rest is history.”
Inflation is now down. What strikes me is that economists currently hold very different views on the outlook for inflation. Optimists believe in spotless disinflation. In their view, inflation will return to the 2% target without any economic problems.
“A significant reduction in food price inflation is also on the horizon”
Inflation will no doubt decline further in the second half of this year in many countries. Last year the prices increased significantly in a few months to come. If prices in those months do not rise or rise less this year, the inflation rate will fall, the well-known base effect. Energy prices are also currently falling which depresses inflation. Food prices follow energy prices and international agricultural product prices with some lag. As the latter are now also arriving, a significant reduction in food price inflation is also on the horizon.
In the United States, higher rents, which in May were still responsible for 2.8 percentage points of inflation of 4.0 percent in the United States, will weaken in the coming months. This is how economists dig into the details of price statistics. It is certainly possible that inflation will approach 2% by the end of the year in many places. The question, however, is whether it will stop there.
What the inflation optimists are missing
In my opinion, all that detail analysis is little more than millimeter-squared nonsense. The “immaculate disinflationists” forget two important things. First, the decline in inflation in the coming months will be driven mainly by the absolute decline in energy and food prices. Of course, those prices aren’t going to keep falling.
What even inflation optimists ignore is that unit labor costs are the main determinant of inflation over the medium term. The wage increases we are currently seeing, both here and in the US, are too high to keep the inflation rate at 2% over the medium term. The current tension on the labor market makes wage growth unlikely to weaken sufficiently in the foreseeable future.
Over the next few months, it will appear that the inflation optimists are right. In response, the ECB will stop raising interest rates within a few months. But beware of a subsequent acceleration in inflation driven by unit labor costs.