How much inflation will come as a result of fiscal stimuli?
The analysis by Alessandro Fugnoli, chief strategist of the Kairos funds , on inflation and fiscal stimuli
Too much of a good thing is a fairly common expression of the English language. It dates back to the sixteenth century and is also found in Shakespeare. In short, there is a measure in all things, as the Greeks said, even in the beautiful, good, pleasant and positive ones. Excess is counterproductive.
But as often happens, to a maxim of apparent wisdom that comes into use, it goes to counteract another of the opposite sense, often just as fortunate. In Italian, for example, unity is strength circulates quietly next to those who do it for themselves makes for three.
And so it has been in English since Mae West, actress and author of great transgressive intelligence of Hollywood and Broadway of the golden years, wrote one of her most famous allusive lines, you can never have too much of a good thing , non you never have too much of a good thing, which has since circulated in English with the same frequency as the moderate original it is opposed to.
The passionate debate that has opened in America among Democratic economists on Biden's fiscal policy revolves precisely around the possibility of excess of a good thing. Given that an expansive choice is indispensable in a context such as the present, there is the possibility that the proposed measures are excessive and dangerously inflationary or, on the contrary, we must think that there is never too much of a good thing and that a spending package the bigger the better?
Larry Summers and Olivier Blanchard support the first hypothesis. These are the two most authoritative and influential exponents of the global mainstream (Clinton the first and the spearhead of the powerful Peterson Institute the second) who until yesterday spent themselves in promoting expansionary policies, arguing in particular that, in a world of zero, governments that borrow for investments that have even a modest return on growth do not increase the debt / GDP ratio but on the contrary, lower it.
It is also striking to see them now very critical of the predictably one and a half trillion package that will be approved by Congress in two months. The fiscal measures taken to mitigate the 2008 crisis, Summers says, were half what was needed, but this time around we are five times the output gap created by the pandemic. If we add to this the trillion coming by the end of the year for infrastructure and high household savings formed for subsidies and lower expenses during the lockdown and ready now to be spent, the inflationary potential is evident. The US economy is not in danger of overheating, says Blanchard, it is in danger of catching fire.
Bill Dudley, until recently number three of the Fed and iron Democrat who in 2019 had urged the Fed to cause a recession to avoid re-electing Trump, also expressed his concern. There are nine reasons for Dudley to fear brisk inflation in the coming months. Among these, the most interesting are the speed of recovery, the permanent reduction of supply in the sectors affected by the pandemic in the face of a demand that will soon return to normal, the frictions in the labor market (a restaurateur who has closed his business does not convert easily a wind turbine designer) and inflation expectations that continue to rise and can themselves help drive prices up.
Defending Biden are Jason Furman and Austan Goolsbee, both formerly in charge of Obama's economic advisers and on historically liberal but not progressive positions. Much of the stimulus, they say, will be one-off, starting with the famous $ 1,400 check that will go to every American with an income of less than $ 75,000. Even if we have a couple of years with nominal GDP growth of 8-9 per cent, made up of only half of real growth and inflation for the rest, it will not be a tragedy.
To complete the debate, there is no shortage of progressive area Democrats like Ocasio-Cortez and MMT economists who even argue that Biden's package is too small and provides very little for the environment.
What to say? Let's try to make some observations.
The first is that if the world has decided to step on the accelerator until inflation comes, it will inevitably come. If it does not arrive, in fact, someone will immediately get up to say that we can accelerate even more and this someone will be installed in power by the voters instead of those who are satisfied with lower growth.
In particular, Democrats have a year and a half to prepare for the November 2022 mid-term elections and to avoid losing the two branches of Congress. The necessary strategy, apart from dividing the Republicans between Trumpians and antitrumpians fighting each other, is to make the economy grow as much as possible and as soon as possible, whatever the cost.
The second observation is that all the arguments of the ongoing debate between Democrats and in the market are based on the notion of output gap, which in turn is based on that of non-inflationary potential GDP. And here the economy enters the ocean of metaphysics at full speed, because the potential GDP, that wonderful world in which there are few unemployed, so much growth and low and stable inflation, everyone can define and calculate as they wish. Calculating it in the traditional way, on the historical series, we tend to underestimate it even dramatically, as has been done in the last decade. Underestimating potential growth means growing less than it could be because inflation is feared that will not arrive.
Summers and Blanchard, aware of the limitations of the concept of output gap, are down to earth and, without many models, they limit themselves to taking pre-Covid GDP and from this they calculate where we would be today if there hadn't been Covid. The difference is the output gap, the hole, which Biden's packet fills not once but five times.
The problem, however, is that the output gap should be calculated on a global scale. In a world that is still fairly open to trade, in fact, the excess demand generated by the fiscal push can be satisfied from abroad without inflation as long as an oversupply remains abroad. In other words, much of the American stimulus will end up in Europe and Asia, where there are still ample unused resources that can be put to work without creating inflation.
If there is inflation in any case, third observation, let's not expect, as Summers does, that the Fed will react too much, reducing Qe and raising rates. Recall that, between the end of this year and the beginning of the next, the top three positions in the Fed expire, including Powell. If they want to be reconfirmed in their positions, Powell, Clarida and Quarles will have to immediately show themselves perfectly aligned with the line of recovery at all costs (and they already are). If they show even the slightest ambition not to ignore it when inflation arrives, Yellen, from the Treasury, will replace them with even more docile doves.
Fourth and final observation, if one day we decide to curb an overheated economy, it will be done more with taxes than with rates. It is the spirit of the times, also aligned with MMT, which argues that taxes are not the tool to pay for expenses (which can very well be paid by printing money) but a means to counteract the excess demand that produces inflation.
What conclusions can you draw for investment choices? In a world pushed to grow at all costs and with inflation that will rise (as much or as little as we will see), long government bonds will give negative returns in real and, probably, even nominal terms. Only the BTPs, for specific factors, will give a positive return. The credits will still give a positive return due to the compression of the spread but will have to row against the current. Equities will continue to do well as long as inflation stays below 3 percent. Above 3 there will be volatility, but the real asset characteristic of equities will make it preferable to alternatives. Commodities will do very well, heading towards a secular rise.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/quanta-inflazione-arrivera-per-effetto-degli-stimoli-fiscali/ on Sun, 14 Feb 2021 14:51:49 +0000.