Comment: Is high inflation a problem of the past?

This article first appeared in Wealth, The Edge Malaysia Weekly, on February 22, 2021 - February 28, 2021.
Comment: Is high inflation a problem of the past?
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Ten months of deflationary numbers in 2020 plus the fact that inflation has remained subdued since the 2008 global financial crisis (GFC) may have lulled many people into thinking that inflation is a problem of the past.

Looking back at history, from the early 1970s until the 2008 GFC, “nipping inflation in the bud” has been a key priority for most central banks across the globe. 

One may recall that from the early 1970s until the early 1980s, the world economy was hit by a period of high inflation, and fighting inflation became one of the toughest challenges faced by central bankers and policymakers. The global inflation rate in 1974, to put things in perspective, was 13%. The targeted rate for inflation is around 2%. In Malaysia, it was no exception — the inflation rate in 1974 was 17.33%! And in 1981, it was 9.7%, which was still very high by any yardstick.

But the 2008 GFC caused a point of inflection, not only for inflation but interest rates as well. In 2009, inflation fell to 0.58% and has averaged 2% until 2020.

In tandem, low interest rates, implemented since the 2008 GFC, have not managed to return to pre-2008 levels. In the face of the current pandemic-induced recession, there is very little likelihood of interest rates going up any time soon.

Conventional thinking is that a prolonged period of low interest rates will eventually lead to rising prices. This is on the premise that low interest rates discourage savings and spur consumption, increase borrowings and, overall, spur economic growth. But since 2008, inflation has remained benign despite the massive fiscal and monetary stimulus seen across the global economy.

And, expectations are that the latest rounds of massive global fiscal and monetary pump-priming to mitigate the impact of the Covid-19 pandemic on the economy are unlikely to lead to higher inflation in the medium term.

Instead, there have been observations that despite the low rates, consumers are saving more, simply because widespread movement control efforts to break the spread of the virus have curtailed consumer demand. Businesses are not investing, whether for expansion or otherwise, simply because of the great uncertainty that the pandemic has posed. Additionally, unemployment has been on the up and up (4.8% in Malaysia’s December data).

Hence, the consensus view is that inflation, while not quite dead, will not be a concern, at least for the next two to three years. This will be a welcome respite for policymakers, who currently have more than enough on their hands combating the pandemic-induced recession.

Of course, the danger is deflation. Japan’s Lost Decade (1991-2001, when growth stagnated and inflation fell below zero) showcases the dangers of prolonged deflation. While the global economy is not quite in a deflationary mode, a continued fall in prices may well tip the world into a deflationary period. As seen in Japan, reflating the economy will not be an easy task. Until today, the country has not quite managed to get back on a high-growth path and interest rates have remained low. 

Having said that, most economists believe that inflation will come back this year as the global economy starts to recover. In Malaysia, inflation is forecast to rise gradually to average 1.5% to 2.5% in 2021.

Still, it may be prudent to see inflation as a problem that is not dead but lurking in the background. Indeed, if we look at the underlying causes of the high inflation rates in the 1970s, we are actually seeing some of them being reprised today. And this should really provide some food for thought.

What are they? Key among them are high debts, rising protectionism and deglobalisation, a deterioration in central bank autonomy as well as a bigger role played by the government in the economy.

The unprecedented amount of fiscal spending and monetary easing since the 2008 GFC has led to a pile up in global debts but since the onset of the pandemic, global debt levels have soared. The World Economic Forum notes that global debts have risen by US$20 trillion since the third quarter of 2019, and by the end of 2020, total global debts should hit US$277 trillion or 365% of global GDP. Indeed, the high global debts may well be a ticking time bomb, and when an upturn comes, governments may inflate their way out of the debt conundrum.

One of the reasons the world has been able to curb inflation after 1980 was the onset of globalisation. For one, surplus supply in intermediate goods in one region was being sent to other regions that were facing shortages. Competition also helped bring down prices. 

But today, partly because of the pandemic and supply chain disruptions, some major economies like the US have begun to look inwards. Protectionism is also on the rise. This could eventually translate into higher prices for goods and services.

For now, deflation may be the bigger concern, but inflation has not gone away. In today’s topsy-turvy world, conventional economic theories can be turned on their heads. In these unusual times, it may be wiser to expect the unexpected.