• 
• 
• 
• 
• 
• 
• 

Print this page

Send by mail

RSS feed

Contact us

Add to Favourites

Increase font size

Decrease font size

In the fall of 2008, the start of the financial crisis provoked the return of the spectre of deflation - analogous to an economic depression. Under the weight of the collapse of the investment bank Lehman Brothers, this dislocation of part of the global financial system fuelled fears for several months that the economic recession would break out into a full-blown depression. Interbanking relations froze resulting in a severe contraction in investment and global trade in late 2008, early 2009, which set off the economic crisis.

Unlike the Great Depression of the 1930s, during which orthodox monetary policy and protectionism exacerbated and prolonged the crisis, the policy makers of the G20 were able to implement adequate measures in order to avoid repeating the worse-case scenario. Thus, tough action by the central banks and stimulus packages removed the risk of deflation and depression.

Avoiding past mistakes
In the 1930s, the administration's belief in free and unregulated markets was such that Andrew Mellon, the US Treasury Secretary at the time, was quoted as saying: "liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate". The drop in the price of goods and services as well as salaries was supposed to allow the economy to return to equilibrium and the markets to function normally again. However, this strategy led to a 30% drop in prices and persistent unemployment of over 25% for several years. Today, the risk of inflation seems to have gained the upper hand due to extremely accommodating monetary policy.

Commodities spur inflation
Consumer prices have headed upwards amid an environment marked by low interest rates. Global inflation is expected to reach 4.5% on average this year, according to IMF forecasts, versus 3.7% in 2010 and 2.5% in 2009 when it was at an all-time low. Obviously, exploding commodity prices, including energy and agricultural prices, are playing a significant role. The price of oil has more than trebled since bottoming out at the end of 2008, while the price of other commodities doubled over the same period.

Inflation is especially a problem for emerging markets.
However, a distinction between developed countries and emerging markets can be drawn as the economies of the latter group are overheating. The financial crisis had little or no impact on their financial systems and lending has rocketed. This has fuelled growth and could create a risk of a bubble forming, particularly a real estate bubble. Monetary policies remain extremely loose out of fears of attracting excessively high inflows of hot money. Many countries that control the float of their currencies have left their key rates at very low levels, thus breading the credit bubble. The monetary policy tightening that is currently underway coupled with macro-prudential measures intended to limit economic agents' use of debt should contribute, however, to stabilising inflation over the coming months.

However, in the developed countries (United States, Europe, Japan), the risk of inflation appears to be more remote. The rising price of oil will, of course, be felt in the consumer price index, albeit less so than in 2008 when the price of oil jumped to USD 145 in early July. However, economies are still nursing their wounds and remain dependent on the support of economic policies. Consequently, unemployment remains high (9% in the United States, 10% in the euro area) and production capacity has yet to return to its pre-crisis level, except in Germany. Lastly, lending also recorded a moderate improvement (around 3% per year), which is slower than rates up to 2007, as households and companies have little appetite for taking on more debt.

In these conditions, it is hardly surprising that, once stripped of its volatile components (i.e. fresh foods and energy), underlying inflation is barely over 1%. The second round effects feared by central banks, particularly the ECB, have yet to materialise: to this point, rising consumer prices have not led to higher salaries, which could spur inflation. In all, the fixed income markets have not reflected expectations of runaway inflation on a 5-year horizon.

In the medium term, the economic environment will naturally be marked by greater inflation
However, it is clear that the period of disinflation of the past 20 years has ended and the status quo is expected over the course of the coming decade. Several phenomena combined to maintain inflation at a low level in the mid-1980s. The first was the disinflationary commodity price shock. The price of oil fluctuated between USD 15 and USD 30 during the 1990s and into the early 2000s, which, in real terms, was a relative decrease in price. The arrival on international job markets of 1.5 billion new Indian, Chinese and workers from other emerging markets increased labour supplies quickly and drove production costs lower. This came at a time when policies promoting free trade, including the adhesion of China to the WTO in 2001 (one of their most important consequences) stimulated the development of direct investment and international trade. Lastly, the cost of capital remained remarkably low due to policies that kept interest rates deliberately low in the United States, which favoured the use of debt leverage.

In the future, these factors will reverse. The active Chinese population is going to begin to stagnate then decline in the next few years. Policies shifting the focus back to domestic demand will justify a jump in salaries and the exchange rate, which will factor into the price of imports for western countries. Input prices, and in particular commodity prices, will continue their structural increase given the needs of emerging markets. Lastly, the new banking regulation constraints will have an impact on the cost of lending.

The risk of stagflation in the near term appears low but could materialise in the future. The lessons learnt in the 1970s proved that an arbitrage between inflation and unemployment, unlike what was believed in the 1950s and 60s, does not exist. As a result, the central banks are expected to react to inflationary pressures, even if questions - for the time being – remain focused on exit strategies, in particular for the US Federal Reserve.