Demand destruction ≠ disinflation
Global central banks have a “everything in it“Efforts to bring forward policy tightening to dampen demand.” But weaker economic data within the United States and that Eurozone have exacerbated fears of recession. As growth prospects dim, many assume this can occur Demand destruction result in lower inflation. That is, tighter monetary policy and the associated higher financing costs will curb demand and offset supply shortages as a consequence of geopolitical instability and provide chain disruptions. This view relies on the assumption that inflation outcomes are largely determined by the policies of central banks.
However, “muted” Inflation lately, particularly during the 2014 to 2016 crude oil crash, has shown the insensitivity of inflation to demand-side measures. Even the European Central Bank’s (ECB) quantitative easing (QE) in 2015 failed to boost demand enough to reduce oversupply. The US Federal Reserve’s dovish monetary policy stance in the decade before the pandemic fueled the crisis Atlanta Fed Wu-Xia Shadow Federal Funds Rate Although the worth fell below zero on several occasions, the Fed’s preferred price measure, personal consumption expenditure (PCE), reacted less to such policy changes than to the tip of the Cold War or China’s entry into the WTO and other catalysts.
Personal Consumption Expenditures vs. Shadow Federal Funds Rate
Likewise, recent quantitative tightening and rate of interest hikes haven’t led to sufficient demand destruction to counter geopolitically driven raw material shortages. Rather than following central bank policies over the past twenty years, inflation has largely moved in parallel with commodity prices or each demand and provide side aspects.
Eurozone, USA and Great Britain Inflation vs. Commodity Index
This raises doubts concerning the “interest rates determine activity and determines inflation” framework and suggests that domestic monetary policy alone cannot raise or dampen inflation. Other aspects must come into play.
1. Tax spending = higher demand
Given the quantitative easing measures long and variable Because of the trickle-down effect, pandemic-era policies attempted to deal with the demand deficit by expanding balance sheets and thru fiscal stimulus or by printing money and sending checks on to households. That’s drastic the transmission time between central bank easing and realized inflation shortened. The use of “Helicopter money“Demand picked up quickly.
As the pandemic-related disruptions subsided, the expected fiscal tightening never materialized. Instead, fiscal-monetary cooperation became the norm and Cash payments an everyday political instrument. Afterwards Eat Out to Help Out programFor example, the British government announced a £15bn package to send £1,200 to thousands and thousands of households. As energy prices soared in Britain, Liz Truss, the leading candidate to turn out to be the following prime minister, proposed an emergency budget spending package to ease the financial burden on the general public.
There are many US states on the opposite side of the Atlantic announced stimulus payments to ease the pain of high inflationand President Joseph Biden has introduced a student loan relief program. The lesson is evident: in terms of economic stimulus, central banks aren’t any longer the one players.
2. Geopolitical events = supply disruptions
As a multinational company Regionalization, nearshore and re-shore supply chains And if we prioritize resilience and redundancy over cost optimization, the Eurozone energy shortage has created recent disruptions. German chemical production is prone to fall in 2022, that might be the case Export inflation abroad.
As geopolitical instability contributes to domestic economic challenges and more fiscal stimulus is deployed, inflation could also be much less conscious of traditional monetary policy aspects. Under such circumstances, a rigid framework that equates tight monetary policy and high prices with demand destruction and disinflation will now not be viable.
For investors calibrating their portfolio risks, such conditions can offset the disinflationary pressures of a growth slowdown.
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Photo credit: ©Getty Images / Pavel Muravev
