Is There Deflation or Inflation in Our Future?

Yves here. This article is particularly timely because some articles in the financial press were already onto the “ZOMG spending! Next inflation!” meme. While we’re already seeing shortage-induced price increases in some food items, that isn’t the same as broad-based inflation.

Having said that, the one way we could get to inflation is if there is a massive loss of productive capacity, and the remaining people with money can bid up the comparatively small amount of output left.

Recall that when Olivier Blanchard was Chief Economist of the IMF, the Fund published a study that effectively admitted that austerity didn’t work in depressed economies. Not that that wound up changing anything.

By Olivier Blanchard, Fred Bergsten Senior Fellow, Peterson Institute; Robert Solow Professor of Economics Emeritus, MIT. Cross posted from VoxEU

Will falling commodity prices, stumbling oil prices, and a depressed labour market bring low inflation and perhaps even deflation, or will very large increases in fiscal deficits and central bank balance sheets bring inflation? This column argues that it is hard to see strong demand leading to inflation. Precautionary saving is likely to play a lasting role, leading to low consumption, and uncertainty is likely to lead to low investment. The challenge for monetary and fiscal policy is thus likely to be to sustain demand and avoid deflation rather than the reverse.

Is there deflation or inflation in our future?  Some observers point to falling commodity prices, stumbling oil prices, and a depressed labour market and see low inflation, perhaps even deflation as far as forecasts go.  Others point to the very large increases in fiscal deficits and central bank balance sheets and see inflation, perhaps even high inflation.

I put most of my probability mass on the low inflation forecast. But I cannot completely dismiss a small probability of high inflation.1  Let me explain.

The standard way of thinking about inflation is to look at the state of the labour market, inflation expectations, and shocks to commodity and food prices.  This framework has served us decently well (not great, as attested by the debates about the death of the Phillips curve, see Blanchard 2017)  for the last 30 years.  And through those lenses, it is hard to see inflation pick up any time soon.

Unemployment is exceptionally high, and even if, when the lockdown is relaxed, it will be partly matched by exceptionally high vacancies, it is hard to see a strong wage push on the horizon.  Commodity prices have fallen, oil prices have collapsed, putting downward pressure on inflation.

One might have worried that the large fiscal programmes to help liquidity-constrained households and firms would lead to demand exceeding the lower available supply.  It has not happened, as there has been a large increase in saving, both because of the limits on shopping from social distancing and because of precautionary saving.  While the price of some products has increased, inflation rates have, if anything, decreased since the start of the lockdown.  (In the US, the consumer price index decreased by 1.2% at an annual rate from February to March).  One may still worry that, when social distancing is relaxed, pent up demand will lead to a burst of spending, and some inflation.  If it happens, it is unlikely to be large and long enough to destabilise inflation expectations, and it is likely to disappear quickly.

Looking beyond that, it is hard to see strong demand leading to inflation.  Precautionary saving is likely to play a lasting role, leading to low consumption.  Uncertainty is likely to lead to low investment; unlike a regular war, there is no capital to rebuild.  The challenge for monetary and fiscal policy is thus likely to be to sustain demand and avoid deflation than the reverse.

This is why I put most of my probability mass on low inflation for the few years to come.  We are, however, definitely operating in a non-standard environment and the standard way of thinking about inflation may be wrong.  And I can think of a scenario where there is high inflation.

I believe that three elements must combine for such an outcome.

  • First, a very large increase in the debt to GDP ratio, larger than the 20-30% or so under current forecasts.

This is not a crazy hypothesis. The exit from the disaster relief policies may be very slow, leading to large deficits not only this year but also next.  The early start of deconfinement is likely to lead to more waves, a second and perhaps more after that. Given the precarious state of many households and firms as a result of the first wave, each successive wave may well require more and more fiscal spending for disaster relief. Multiply the initial fiscal package by 2 or 3 and this leads to a large increase in the ratio of debt to GDP.

  • Second, a very large increase in the neutral rate, that is the safe real rate needed to keep the economy at potential.

This may be because the demand for sovereign bonds is downward sloping, and the increase in supply requires an increase in the rate for investors to absorb it.  We do not have a precise sense of the effect, and the range of estimates is that an increase of one percentage point in the debt-to-GDP ratio increases the neutral rate by 2-4 basis points.  So, assuming an increase in the ratio of debt-to-GDP of, say, 60%, this might lead to an increase in the neutral rate of 120 to 240 basis points, an increase that would get the neutral rate close to or above the growth rate.   Or the neutral rate could increase for other reasons, a decrease in saving, an increase in investment demand, a decrease in risk aversion; none of these seems likely, but we have a sufficiently poor understanding of the determinants of the neutral rate in the past that we cannot exclude it.

  • Third, and perhaps most important, fiscal dominance of monetary policy.

Faced with an increase in the neutral rate, the Fed should increase the actual policy rate in parallel, in order to avoid overheating.  But this would increase debt service, requiring a potentially large fiscal adjustment to avoid a debt explosion.  The government might be tempted to ask the Fed to keep the interest rate low, so as to decrease the debt burden. While today’s Fed would not yield to such pressure, a future Fed, with a chair appointed by a populist president, might be more willing to bend and keep rates low for too long, leading to overheating and inflation. While some inflation is desirable, the lessons from past episodes of high inflation is that this process typically ends badly: inflation expectations might de-anchor, leading to higher and higher inflation, perhaps even hyperinflation.  This would reduce the real value of the debt, but not without major costs for the economy.

As I have made clear, this scenario requires the combination of three ingredients, each of them with low probability.  Put your own probabilities and multiply them: the resulting probability is very small.  I asked some of my colleagues for their probabilities, and the product always came below 3%. (The probability is even smaller in the euro area, where it is hard to see the fiscal authorities get together to impose fiscal dominance on the ECB.)  But it is not quite zero.

Looking at the yield curve for inflation-indexed bonds, investors do not appear to anticipate anything like this scenario.  They do not see a substantial increase in the neutral rate: the yield curve for inflation indexed bonds is negative throughout the maturity structure.  They do not see an increase in inflation any time soon: the expected inflation proxied by the difference between the rate on nominal bonds and inflation-indexed bonds is about 1% below the Fed target of 2% throughout.  I am on their side, but I do not completely dismiss the probability that things could turn wrong.

Editors’ note: This column appeared on the PIIE RealTime Economics Issues Watch blog.

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  1. PlutoniumKun

    I think Yves point about productive capacity is extremely important. The post Covid economy in many countries will look very different, with a huge loss of service jobs, maybe permanently. Most historical bouts of high inflation were associated with a loss of productive capacity, so its important that government measures include very specific measures to increase output, preferably by focusing on restoring and renewable energy investments.

    Unfortunately, so far we’ve seen the ‘big’ economies, especially the US and China, falling back on old playbooks. In the US its goosing share values, in China, its throwing cash at pointless concrete pouring. The South Koreans may not necessarily be getting things right – Moon has just announced huge financial support for the ship building industry at what might be just the wrong time (there is likely to be a huge glut in capacity soon). The Japanese seem to be a bit more focused, and as usual, in Europe they are still having an argument.

    1. Watt4Bob

      I assume the Chinese ‘pointless concrete pouring‘ is a lot of new stuff.

      Do you think the obvious need for over-due infrastructure maintenance make the possibility of pouring concrete in the US a smart option?

      1. PlutoniumKun

        Infrastructural investment is a smart option in the US, because there has been decades of severe underinvestment, so if done correctly, it should raise productivity within the economy. In China, the problem is that they have been consistently building bridges (and railways, and everything else), to nowhere, because infrastructural investment is the main way they’ve used to keep growth consistently high. The productivity returns to investment are now very low in China. If you go to Michael Pettis’ blog he has some interesting long form essays on the particular problems with over investment in China and the imbalances it is causing the economy. Essentially, China needs consumer demand, not more roads and railways, the US is the opposite.

        1. Ian Ollmann

          I wonder if part of this is the natural result of “starve the beast” for the last 40 years. Who buys consumer goods? Consumers. Who buys infrastructure? Government.

          It is not always the case that for the private sector to have more the government must have less. The government sometimes buys things for consumers, like bridges and freeways. We can not always say no to investment.

          1. epynonymous

            I like the theory that towns and states are in for a few years of lower budgets. Conveniently, this enables central government expansion to go unopposed. Even with the emergency, it seems cultural conservatives are still mad about sanctuary systems.

            Extra private saving by the non-privileged classes can always be eliminated by government fiat just as quickly. I’m lucky enough to have an out of the federally mandated health insurance, but with a conservative supreme court in the US, then ‘the power to tax a thing is the power to destroy a thing’ seems like a possible regulatory response. Of course, they won’t call it a tax, it’ll be one of those public-private projects where we become a massive rent farm. Corona Bonds is missing the point, rent extraction can tax more direct forms. Maybe an internet tax could pass if their lobbyists in Europe don’t figure out some accommodation.

            1. JTMcPhee

              How about that disappeared tax on financial transactions? A fraction of a cent on high speed trading, other taxes on other financialization scams, and presto! Balanced budget, or something.

              It’s not like financial shenanigans contribute a damn thing to the “productivity” of our political economy, other than increasing the power of the very few to screw over the rest of us by buying up the legislatures and executives and courts.

              Not that these notions have any legs…

        2. Tom Bradford

          Essentially, China needs consumer demand, not more roads and railways, the US is the opposite.

          Yes, but concrete pouring on an industrial scale demands skill and experience. “Infrastructure projects” aren’t built with pick and shovel as they were in the 1930’s.

          The NZ Govt. has announced that it’s looking for infrastructure projects that are ready to go pretty much straight away, but on gaining power three years ago it embarked on an ambitious project to build thousands of ‘State houses’ to ease the country’s housing problem – a project that failed simply because there weren’t enough skilled bricklayers, plumbers, electricians and carpenters sitting around waiting for something to do.

          Moreover the great infrastructure projects of the 1930’s drew in the unemployed from far and wide, and housed them in temporary camps for the duration. Who’s going to put up with that today?

            1. Watt4Bob

              I don’t understand what’s at play here?

              Is this sort of like fracking, in that it’s mostly a finance play, with no intent that anyone but the banks profit?

    2. MLTPB

      Some new playbooks are not better than old ones.

      Japan could be supporting ship building industry, instead of Korea doing that.

      China then gooses share values instead of US.

      We over here can argue like the Europeans.

      Do we see here that new is better than old?

      1. PlutoniumKun

        Japan has a thriving ship building industry, but its mostly for domestic use – a huge proportion of goods transport within Japan is by ship between the big port cities (Japanese railways being generally unsuitable for goods transport because of narrow gauges). So building ships is appropriate for Japan if they want to step up domestic manufacturing.

        The problem for Korea is that they’ve focused on sectors like monster sized container vessels, oil exploration vessels, and cruise liners – precisely those sectors which are likely to be hit very hard over the next few years.

        1. MLTPB

          You’re right.

          If Japan goes in that hypothetical direction, ship building, it would be a new play and not necessarily a good one.

    3. Andrew DeWit

      Odd that the piece overlooks demand for critical raw materials. Naked Capitalism ran quite a few good items on the massive material (cobalt, lithium, rare earths, copper, graphite, etc) problem confronting the green (or clean) new deal proposals, and the UNECE just did one on COVID and critical raw materials ( Surely heightened demand for digitalization, vehicle battery storage, all-electrification, distributed generation-transmission-storage, and so on suggest that inflation is a risk unless industrial policy maximizes secure supply and efficient use.

    1. MLTPB

      That things go up a lot, very quickly, and go down a lot, also very quickly, presents another problem, beside inflation and deflation.

      That problem would be system instability.

  2. divadab

    Well it seems to me that there will be deflation in the short run and therefore a good idea to keep cash on hand. Note that financial asset values have deflated significantly and real estate will react slower but over the next year or two will be a buyer’s market.

    As to labor, I suspect wage inflation will ramp up a lot before RE recovers. In my experience, RE asset values take years – just look at the 1990 – 2008 curves of CA real estate values – to adjust in both directions.

    Interesting times. We’re in a wartime economy without the war. And without work. All by government fiat. Let us hope this thing is resolved peacefully, as the warmongers are doing what warmongers do in the face of popular discontent.

    1. Mikel

      “Note that financial asset values have deflated significantly and real estate will react slower but over the next year or two will be a buyer’s market.”

      Major Indexes are around the late 2019 area. Not really indicating a significant drop, especially when many thought late 2019 prices were bubblicious.

      All indications point to real estate market that will get much, much lower with commercial real estate leading the way. But everything is lining up in a way for everyday people not to be able to take advantage of it.

      1. divadab

        A 30% portfolio drop is not unusual for a fully invested, 100% equity portfolio, especially with Oil and Gas exposure. This seems to me to be significant, since in 2008 a 26% drop was considered catastrophic. (Of course, your performance may vary – a portfolio 40% in bonds will not have dropped as much).

        Not sure how you conclude “everyday people will not be able to take advantage of it” but a lot of everyday people have cash assets and they will certainly be able to buy RE after the adjustment. Banks don;t stop lending on RE – it seems it’s the only thing they understand these days.

    2. rd

      I think the “without war” part is important.

      If we look at the New Deal and WW II, those were major expansions of the national debt and did not generate inflation (WW II price controls play a role in that).

      Most of the major inflation episodes were where controls lost control over their currencies or flexibility of their payments (emerging economies with US$ denominated bonds, Weimar Republic). Since the US is still demonited in US$, I think the big quesiton about inflation potential for the US is whether or not the world believes the US has lost its marbles. If the US is putting fiscal funds in place to address things in a coherent fashion, then I think buyers will be in place for bonds and we will ahve deflation or neutral conditions. If the world believes the US has gone nuts and is moving towards being a failed state, then I think bond demand will drop and inflation could kick in. Trump press conferences may be an important component in this evaluation, especially if he is re-elected.

      I do have some significant holdings in TIPs and foreign stocks in my 401k/IRA just in case our currency does a face-plant like the late 70s.

    3. John Wright

      Speaking of warmongering in the middle of a pandemic.

      This is from March 5, 2020

      “After our troubles in Iraq and Afghanistan, many Americans just want the United States out of the Middle East. But Syria is not Iraq. With just a few hundred soldiers and some help to our allies, the lives of millions can be spared from Assad’s cruel rule. And if we allow this slaughter, there will be more slaughters to come. We have a moral imperative to try to stop that.”

      Now the USA has a “moral imperative” to wage a new military action.

      And it can be done with a “few hundred soldiers”, so what is not to like?

  3. a different chris

    >The standard way of thinking about inflation

    …is to come up with whatever answer TPTB want you to come up with. Deflation will make those with money richer and give them an excuse for no raises “hey a gallon of milk is so cheap they are pouring it out on the ground!” Inflation will show the little guy who is boss. “We can’t hire anybody else we’re getting killed on inputs”. Keeping it nominal will make it look like TPTB know what they are doing “Don’t listen to AOC, see how smart Larry Summers is!”.

    Just keep adjusting that “basket of goods” guys, you can do it!

    Economists make fun of “the world’s first profession” but it’s a lot more respectable than what most of them do.

    1. juno mas

      “hey a gallon of milk is so cheap they are pouring it out on the ground!”

      I believe milk was being poured on the ground because the supply chain was broken. If you can’t transfer milk quickly no sense in attempting shipment. Milk was being spilled because it couldn’t get to market.

      1. rd

        The US supply chains have been over-complexified to achieve “efficicency” so that if anything goes wrong, the ripple effects are massive. This is a primary system re-design challenge for the next decade. Globabilization is just one component.

        Toilet paper and milk challenges are largely because there are two completely separate product lines, markets, and distribution networks for commercial vs. private consumers. They are both efficient, so it takes time, money, and effort to re-purpose. “The Goal” by Elijah Goldratt was looking at this type of efficicency challenge inside a business 25 years ago. Optimizing every component of a system leads to a sub-optimum and non-resilient system.

  4. Scott D

    I went to my usual pet store for some cat food. Everything in the store is priced 20-30% higher than it was 3 weeks ago.

    1. The Historian

      It’s important to remember whose economy this article is talking about. It isn’t ours. For instance, the author states that the price of commodities has fallen but that isn’t showing up at the grocery store or the gas stations in my area. Gas is only 6 cents cheaper per gallon than it was 2 months ago, and now that I shop every two months, it is easier to compare prices – and for this latest shopping trip, I noticed everything was more expensive, particularly meats. TP is now on the shelves and back to its old price though.

      1. Stumpo

        “Whose economy” -yep. My pet theory is that If every time you read about “inflation” in the MSM, You replace the term with “wage inflation”, it all makes a lot more sense. That way the big bad thing we hate is held up to justify whatever cruelties are necessary to prevent the big bad thing they hate, and it’s all so much easier when we just go along with it. Hell, sometimes they aren’t even too worried about concealing their motivations. E.g. “The standard way of thinking about inflation is to look at the state of the labour market…”

        1. JustSaez'in

          Longtime lurker, first post to a valuable site, good Sunday PM y’all. I ask given your monikers..

          Context of trades for a commodity you can sell go below zero (oil) and the ‘whatever it takes crowd’ might inflate away the LTRO et al (eu) at a time of their choosing anyway and since Covid conditions conspire to make it in the interest of capital to keep it’s cost (to store value/interest) low. Is it feasible to install a second currency /starting from the minimum wage (derogation from freedom to contract) and make its use conditional on responsive locally and responsible glo.. I’d hate to use the lower band of earners in society to control consumption but isn’t that sort of the rub, of banking, NC ;)

          My questions, has anywhere tried this before? I’m sure an islet in the UK tried aeons ago but?

          Who gives the best, calculus-compliant, capable of kepping the heating on/phones charging exposé of MMT in modern or digital conditions? Without authority trampling, creeping or overkill, is it Crypto, Adair Turner, BoE!?

          Anyway, something to take my mind off cardrivers in masks, the gall.

  5. Jesper

    The official inflation-rates is (to me) completely divorced from my reality. My major cost is related to the cost of housing and that cost is not (for me) even close to be accurately accounted for in the official inflation-rate.

    The expectation of future interest-rates is often very closely tied to (or even conflated with) expectation of future inflation. The FIRE sector, which is tied very very closely to interest-rates, might see more turmoil than they might wish for. If turmoil is expected then my guess is that there’ll be a flight to safety thus driving up the prices of safe assets. All that might lead to lower interest-rates which should not be conflated with inflation.
    When the lockdown finally ends (whenever that might be) then the ones who have been telecommuting will face the options of:
    1. Continued tele-commuting – those that can and want to continue doing that might then consider tele-commuting from cheaper homes than homes located centrally and/or with good commuting options. Might lead to downward pressure on rents and property-prices in some areas and upwards pressure on rents and property-prices in other areas.
    2. Going back to the office to work – working from home in the long-term requires (my opinion) a decent home-office with proper chair, proper desk, proper monitor(s) and the ability to close the door to the rest of the home. Not all people have that, many might prefer going to the office to work rather than the big change of moving to a home suited for home-working.

    So yes, I agree with the prediction that some prices might go up and other prices might go down while there is still the possibility that the opposite will happen :-)

    1. juno mas

      If you want a better webcam or microphone to communicate from your home office, be prepared to pay inflated prices for both. Modest webcams on eBay have jumped from $60 to close to $100.

      1. ambrit

        Yes, and those e-bay prices are awfully ‘sticky’ on the downside. I have seldom seen e-commerce prices come down, except for the elusive ‘fire sale’ situation. (Then I hold my nose and stack deep on useful items.)
        Add to that the recent USPS up-charging for small packages, and you have a double whammy to the e-commerce sphere. The Bigg Boxx Stores cannot muscle lower shipping rates from the mail services for ever. The low fuel prices will allow this dynamic to continue for a while, but sooner or later, transportation costs will rise, and limit e-commerce.
        Today’s economy is based on Greed. All else follows.

        1. marku52

          My wife was complaining about Trump threatening the USPS unless they raised rates for Amazon. I just said “Works for me. They keep raising my rates and dropping Evil Jeff’s”

          He was also right about China abusing international post as a “developing country” P*ssed me off no end that China post ships Ebay stuff for free, the cheapest I can send anything international, to even Canada, for Dog’s sake, is $15. And it rises to $24 for anything of meaningful size.

          Of course, like all Trump bluster (a six year old with the attention span of a gnat), there was no follow up.

    2. JBird4049

      On number 2, sometimes there is nothing as good as doing something in this person. Working, shopping anything especially clothes, talking about anything…

      It is a pain in the posterior to commute and buying boring basic underwear at a store, but sometimes having a quick face to face, or a full departmental meeting (as much as a waste as they usually are!) or seeing a doctor as he just checks posture, breathing, and pulse instead of a bunch of impersonal tests.

      As for inflation, so many Americans have been effectively making less every single year, sometimes for decades, that I am not worried. If there is anything like, it would have the same nature as an sudden increase in the use of medical care, if we ever get national health care, due to all the sick people suddenly able to be looked at. Or the fact that so many of our medical facilities have been erased by “investors” and others of that ilk seeking more profits. Just because the needs or desires are not being paid for does not mean that they do not exist or have not increased.

      I was going to post just the above, but I think I will expand on this on this. Speaking as an American, the entire American economy is simply f#%$’d up beyond sense or even sanity.

      I once wander around Manhattan and parts of it was wall to wall people night and day. All my life the Market in a Financial District in San Francisco has always been busy although other areas usually been. 850,000 San Franciscans, plus commuters, and (ick) tourists and their cameras into 47 square miles, but…

      Every time I walk around the City it seems more shabby, more empty, less real. The increasing numbers of homeless people, the empty spaces without stores, the slowly growing dead zone along Market Street going in the direction of the Ferry Building. Almost the whole city especially the most expensive parts (for whatever reason) seems to be in decay. There is a housing shortage, yet it looks like apartments and condos sit empty, employment was booming, but pay increases never seems to meet increasing expenses. Yet, developers are still building luxury condos that sit unsold.

      Buying anything but coffee is getting harder as well not because there is no need but because there is nowhere to go. Getting anything fixed also has the same problem. Sure I can go online, but waiting three days for something that might not fit, is cheap crap that will break, instead of going to a unboarded store selling quality stuff seems to be futile.

      Expanding on this the “affordable housing” and the lower cost areas in the San Francisco Bay Area has left and moved, but what used to be a quick 25 minute drive (before traffic got bad) away from the Blue areas of the major cities has turned into 1-2.5 hour drive and 50-100 miles away into the economic dead zones of Red California. Get to the boarders of San Francisco or Oakland, turn north or north and don’t stop for a hundred miles for a place to live.

      Expanding more, from I have read recently of Los Angles and NYC, and connecting to my observations on Manhattan, several paragraphs back, much the same can be said of them. Three cities. Two densely populated. All in supposedly wealthy Blue areas with increasing economic dead zones, empty stores, “missing” housing kept off the market, homeless encampments. Very low(?) unemployment.

      But Washington, D.C. outside of the 3rd world conditions of some of it, is doing just fine. Go there and everything is beautiful. It was supposedly a somewhat seedy place back in the day. Not anymore. However, the glorious areas side by side with the very poor areas seems familiar somehow, like something one would see in a 3rd world country.

      Inflation or deflation is the question? Well, have you noticed that eBay has nice sections on “antiques” or “vintage” items that are often less than thirty years old? And frequently American (And sometimes European) made? Now why would anyone want to buy a thirty, forty, or fifty year old toaster when a new one can bought for less?

      The decades old American or sometimes European one either still works, even if the seller had to check and do some minor repairs, while the cheap Chinese stuff will die in a year.

      One of the reasons I want to buy a style of furniture call Mid Century Modern, besides liking the style, is that even cheaper American made furniture (as opposed to the better made Scandinavian stuff) from fifty years ago is much, much better quality even if I might have to refinish it myself. Can’t afford it right now because poverty although I can buy the cheap stuff that will likely fall apart in five years.

      I can tell you from both selling it and wearing it that clothes are nowhere near the quality of even thirty years ago even for the more expensive clothing. Regardless of cost. Maybe that’s why vintage clothing is so popular.

      Tools, clothes, furniture, etc have all collapsed in quality and prices. Medical care and housing and availability have also collapsed in quality but soared in price. We had an officially good economy with low unemployment, but I haven’t seen that personally on the ground in decades or at least not reflected in both pay increases and a functioning retail.

      Maybe any inflation would first be seen where vintage is sold? People are usually willing to pay extra for quality when they can afford it.

  6. cnchal

    It’s a clear view from Oliviers place in an ivory tower far above the clouds. The problem is he can’t see through the clouds and observe the writhing pain many are in.

    When millions of eviction and foreclosure notices are stapled to millions of doors in the next three months, what does Olivier think the results will be? Sure, prices for meat will surge, but that is due to a supply shock as one meat packing plant after another has mass infections and are closed for deep cleaning theater, but is that really inflation?

    As for the FED being above political pressure:

    . . . The government might be tempted to ask the Fed to keep the interest rate low, so as to decrease the debt burden. While today’s Fed would not yield to such pressure, a future Fed, with a chair appointed by a populist president, might be more willing to bend and keep rates low for too long, leading to overheating and inflation.

    What exactly has the FED done lately, except aim the only weapon it has, the cash firing bazooka, at the billionaires and fire away. No political pressure there, it had to be done so no billionaire was left behind.

    After reading this essay by Thomas Frank, clarity of the word “populist” has come into focus.

    Populist is a euphemism for “stupid peasants don’t know what is good for them”. It’s the jawb of the PMC to get the elite’s message out and order the peasants around

    There is no doubt that the first of the three conditions — large increase in debt to GDP by the federal government will happen — it’s already happened. Look at the trillions the billionaires got, while the peasant got chicken feed.

    The second — the very large increase in the neutral rate — implies “inwestors” are going to require higher interest rates to buy the government bonds, money they got from the FED’s bazooka. Yep, I can see that happening. Money from the FED for next to nothing ploughed into government bonds paying 5%, it’s a no brainer.

    The third — fiscal dominance of monetary policy — begs the question, how are you going to pay for it?

    The billionaires are on record that they won’t pay taxes and do anything and everything to avoid payment, including changing tax laws to their advantage, so the source of revenue to pay for it must come out of the hides of the peasants, even though the money was spent on making sure no billionaire was left behind.

    What can destitute peasants do, when presented with demands to pay the billionaire’s bills?

    1. JBird4049

      What can destitute peasants do, when presented with demands to pay the billionaire’s bills?


      It seems like a growing number of Americans across the political spectrum are getting desperate and angry. That the game is game is rigged against almost everyone as the cards are marked, the dices loaded, and the bat is corked and the only thing that matters is money and the color green is finally becoming accepted.

    2. Philip Hardy

      Nah, us peasants got the empty bag the chicken feed came in! As for the billionaire’s bills; Capitalism works until it runs out of others peoples money to pay the debts. If the billionaire’s won’t pay taxes, and the peasants have nothing to pay taxes on, then the FED has to keep on printing, which it has done for most of the last 12 years since 2008, as has the Bank of Japan, and the ECB. Its a Ponzi scheme, but how do you stop a Ponzi scheme with a handful of buyers who can print all the money they want? What economic blow back will crash it? Political collapse?

      1. JBird4049

        If there is nothing left to buy including, perhaps including food, what’s the point of having all the money? The purpose of money is as a means to exchange things. No money (because the fools hoarded it all) and ultimately no resources (again because the fools hoarded it all) means that there’s no easy way to give or receive whatever and probably none of the resources to make it anyways.

        That is one of the reasons for the collapse of the Western Roman Empire. One of the ways archaeologists judge the age of a Roman artifact is by its quality. The worse or more crude it is the later it was made during the empire. And Probably starting by the end of the second, certainly the third, the closer it gets to the collapse, the quality and sophistication declines. Also, all the poor people either didn’t fight or even joined the invading barbarians.

  7. Edward

    My feeling, for what it is worth, is that there is a basic issue of “reality control”; the United States has been able to impose the rules and relationships it wants on the rest of the world, i.e. “reality”, ignoring fairness, international law, and so on. However, thanks to poor management, the foundations of U.S. power, such as the dollar’s reserve currency status, have eroded, putting these unequal relationships in question. The United States may find itself unable to suck resources and labor from other countries, at which point it will need to become self-sufficient or face inflation.

  8. The Rev Kev

    I don’t know if it is true or not but I heard recently that it is extremely difficult to have high inflation rates when interest rates are hovering near zero per cent. If this was true, then the implication would be that deflation is coming, an idea which seems anathema with a lot of international financial organizations.

  9. jef

    IMO inflation is always a money thing. Which is why it falls under the Feds purview. Prices going up due to shortages is not a money thing, it is a physical reality unless it is artificially induced but even then the amount of money in your pocket is not the cause.

    The Fed has inflation nailed. They can create all the money they want as long as they only let 1% of the population have it. Problem solved.

    So is the question asked about whether the 90% are going to start getting so much money in their pockets that the price of everything will go up? I seriously seriously doubt it.

    Will there be less and less supply of just about everything do to AGW and peak everything driving the price of everything up and up? Abso freeking loutly.

  10. Mikel

    Regarding the writer’s three elements for inflation, aren’t the already happening?

    1) The exit from disaster relief policies is slow. Corona is just one kind of disaster, but a case can be made that financial disaster relief has been going on since 2008. And yes, it should be fully expected for waves of confinement to continue.

    2) “We have a sufficiently poor understanding of the determinants of the neutral rate..”
    Well, that says a lot about that metric and all I can say for now is that borders on superstition: “When you believe in things that you don’t understand, then you suffer

    3) “Faced with an increase in the neutral rate, the Fed should increase the actual policy rate in parallel, in order to avoid overheating. But this would increase debt service, requiring a potentially large fiscal adjustment to avoid a debt explosion. The government might be tempted to ask the Fed to keep the interest rate low, so as to decrease the debt burden. While today’s Fed would not yield to such pressure, a future Fed, with a chair appointed by a populist president, might be more willing to bend and keep rates low for too long, leading to overheating and inflation.”

    It is really #3 that makes me ask: Who is the writer’s audience? Plenty of investors think the Fed has already yielded to such pressure.

    Who is he afraid of spooking that he has to couch his belief in coming higher inflation?

    1. Detroit Dan

      I agree with Mikel. His reference to the “neutral rate” reflects unclear thinking. This concept does not help the author, and it does not help us. I also appreciate Mikel’s point #3.

      Mainstream economists confuse more than they clarify, esp with regard to “monetary policy”. That’s why MMT was invented.

  11. Susan the other

    My god. What hole did Wolfgang Blanchard crawl out of? I hope he has the good sense not to go buy himself a new wig made from the hair of Coronavirus victims. Or late-stage capitalism victims. I’m blithering I’m so annoyed. Everything he says is financialization nonsense – tsk tsk, bonds might not command their old usurious values. My guess is Wolfgang doesn’t understand the neutral rate because he didn’t take calculus and he can’t really follow the regular swings of the S curve; makes his eyes cross. He doesn’t bother to define his terms. He never nails down “inflation” at all. His most obscene observation is that it is a danger to the “economy” to allow “fiscal dominance of monetary policy”. Because, contrary to his own fastidiously fatuous understanding of inflation, fiscal authority will fail to adjust the interest rate to “keep inflation from overheating.” What a twister. So all I can assume is that he is doing stream of consciousness in all good faith for the betterment of society – a society devastated by post capitalist greed and destruction; and an environment on the brink of extinction; and he’s really not worried about civilization’s ability to “absorb” poverty, pandemic, and extraction – he’s just worried about the value of bonds necessary to entice investors so we can fix all that miscellaneous stuff. Jesus. Somebody please give him a cigar.

  12. Knot Galt

    I can foresee some percentage of office businesses maintaining a higher number of tele-commuting employees to justify convenience over higher pay while also reducing the demand for office space. Along with the current glut of retail space on the market ( soon to increase), office space demand will also decrease as successful businesses transfer the burden of triple net expenses to added profit or reduce their footprint.

    With States and cities losing some of their tax base, there will be pressure to put the use of those former assets into an alternative, tax making use. One possibility for growth will be affordable housing; granted if innovation and a form of true competitive capitalism is allowed some room to flourish.

    1. ambrit

      Transforming that ‘idle’ retail space to residential space will be an expensive technical challenge. Modern office buildings are not plumbed for conversion to apartments. The same seems to be true of air conditioning and electric service. A lot of physical retrofitting will be needed.
      Politically, the experience, at least around here, of dealing with ‘orphaned’ residential housing is anti-social. Empty older housing, not derelict, but just unmaintained, is being torn down, usually by the City. No rehabilitation ‘movements’ have sprung up. Residential rents are stagnant, but not falling. That’s one of the malign aspects of a financialized housing market; the actual denizens of the housing are not considered in the decision making process.

      1. JBird4049

        I think that many landlords have pre-decided what the market rate is and will not rent or refuse to lower the rent. Reality be darned. Otherwise, why all the building of luxury apartments in the City.

        But also you are right about the financialization of the housing market, really the entire economy, as making money from rents is often not the goal really. Finding a place to park some money is. Or it has been decided by the developer or the lender that the most profitable part of the housing market is the top 10% or even higher. No need to build housing for all the homeless or the middle class paying extortionate rent. Even when the renters for those fancy apartments or the buyers for the condos do not appear, refuse to lower the asking price because reasons.

        1. ambrit

          Right. In comments over the past few years, my second hand experiences with commercial rents for small businesses have shown that large out of town landlords have consistently ignored local conditions in favour of some quant magicked “natural rate of return.” Several of the small businesspeople I conversed with voluntarily shut up shop for various reasons, high commercial rents being a near ubiquitous refrain.
          My best guess is that this pandemic will ruin most “natural rate of return” metrics based businesses. A giant shake out is in progress.

          1. rd

            Tthey are getting investments from a vast ocean of PE etc. funds. I think a bunch of that will dry up for retail/commercial space and will get diverted to re-industrialization real estate. So a defunct shopping mall may be more likely to be repurposed to new manufacturing/warehouse facilities than commercial/retail space ove the coming decade. To do that they will have to navigate local zoning laws which will not be trivial.

  13. Billy

    The Do It Yourself Craigslist Economic barometer:
    Home and apartment rentals have more than doubled in number in SF Bay Area in the last few weeks and there is definite downward price pressure. -10 to 20%, approximately. Click save page, then file it by address. Go back a few weeks later and compare asking rent. Commercial properties visible on Loopnet, both sales and leases, no big price changes, yet., although a lot of “Motivated seller” tags, whatever that means.

    What happens when people can’t find anyone to rent their mortgaged properties and they are no longer working? Mass defaults unintentional and deliberate on every kind of bill and tax payment might be a workable strategy for Americans to wring more long term aide from the government.

    “Coronavirus will wipe out FORTY PER CENT of the economy, unemployment will peak at 27 million and deficit will soar, Congressional Budget Office warns.”

    1. Trent

      Don’t worry, blackrock will buy up those properties borrowing for .05 like they did in 08. Its the same playbook my friend. They figured you’d forget since 11 years have passed. Wait until they dust of the phrase “green shoots!”

      1. Yves Smith Post author

        Please don’t comment when you don’t know the terrain.

        It wasn’t Blackrock, it was Blackstone.

        And it wasn’t in 08. No one was buying anything in 2008.

        It was after the FHFA, on behalf of Frannie and Freddie, said they were planning to do bulk sales of foreclosed properties. That was August 2011.

    2. JBird4049

      I think I will try that. I just have to ask who is moving or renting? There is always some activity, but since the job market has crashed everywhere, evictions are frozen, and it does cost thousands of dollars to move especially over a long distance. I can see some owners trying to unload their properties as quickly as possible because if Congress still refuses to see reality and does not put through widespread and deep financial aid to the bottom 90% without any of the Democrats’ beloved means testing or the Republicans stinginess, there really will not be an economy. Each day that the aid is delayed just means a deeper hole and that much more trillions of dollars that will have to be printed.

    3. JTMcPhee

      I’m losing track: Am I supposed to FEAR the Deficit, or Embrace It? It’s so confusing. McConnell and Pelosi have these on \-off switches that don’t seem to correspond to anything, except demand from Big Money. How does that connect to deficits and in/de/flatiron? I’m sure there must be an explanation somewhere. Maybe that M and P are just self-pleasers who know their deaths are not that far away, so gorge on barbecue and bespoke gelato…

  14. McWatt


    Why is it that the English newspapers understand the importance of American Government information long before the American press does?

  15. ewmayer

    Sorry, this sounds like the usual mix of disingenuous inanities from someone who surely knows better but does not wish to displease his masters:

    “The standard way of thinking about inflation is to look at the state of the labour market, inflation expectations, and shocks to commodity and food prices. This framework has served us decently well (not great, as attested by the debates about the death of the Phillips curve, see Blanchard 2017) for the last 30 years. And through those lenses, it is hard to see inflation pick up any time soon.”

    “has served us decently well” — who is this ‘us’ of whom you speak? And surely you realize that there are 2 very distinct kinds of inflation – the asset-price and wage varieties – which distinction you omit in your above “standard way” sleight-of-hand. Relentless fretting-about and suppression of wage inflation is naturally what the game is all about for the elite-looter class which Mr. Blanchard serves. As opposed to asset-price inflation, of which there can never be enough, and which thus is invariably framed in positive terms by economists: “a roaring stock market”, “strong housing prices”, etc. And in fact we’ve had a massive bout of it fueled by the Fed printing a cool couple $trillion of monetary meth for the Wall Street gambling houses – how does Mr. Blanchard think the equity markets rallied 20% at the same time the real U.S. economy was suffering its worst spasm of mass joblessnes since the Great Depression?

    So a quick point of future time-saving triage for my fellow readers: any article about “inflation” which does not accurately distinguish between asset-price and wage inflation can be safely ignored as having been written by either a liar or a fool. In the present case, I am reasonably certain that Mr. Blanchard is no fool, except possibly one of the Upton-Sinclairish “It’s hard to get a man to understand…” kind.

    1. Philip Hardy

      IIRC the US stock market rallied four times between the 1929 crash and 1931 when it hit bottom. An economy in a depression does not produce a surplus that will support high stock prices, the message eventually got through in that era, will it now? Or will the FED keep on trying to reflate asset prices?

      I remember a comment about that era from a woman who remained affluent through the depression, “at first everything was cheap, but after a while there was little to buy and it wasn’t cheap”. In other words, the deflation of the 30’s due to the banking collapse, destroyed demand, which destroyed supply, that led to comparatively higher prices as economies of scale and competition efficiencies were lost.

      More key I think is not inflation or deflation per see which are monetary phenomena, but the relationship between income and prices. If incomes are falling faster then prices, everything is more expensive even if officially its deflation. And prices may well be rising while the money supply contracts due to increasing costs mentioned above. Inflation or deflation, most of us are going to get poorer.

  16. John Zelnicker

    While I understand the motivation to pop the bubble of “ZOMG, inflation”, I don’t understand using Friedman Monetarism as the frame of reference.

    First Element: The debt-to-GDP ratio is a meaningless metric. As Rogoff(?) showed, once his spreadsheet mistakes were corrected, the size of this ratio doesn’t tell us much, cf. also, Japan.

    Second Element: Blanchard talks about the need for higher rates in order for investors to accept more sovereign bonds. Investors don’t control the interest rate on Treasury securities, the Fed does. His mention of the savings rate as possibly affecting the “neutral rate” sounds like Loanable Funds Theory which has been thoroughly debunked by MMT.

    Third Element: Monetary policy has been shown to be completely ineffective for the past 20 years, at least. Yet, he wants the Fed to raise rates in anticipation of the possibility that maybe, perhaps, some day, there might be some inflation. The Fed has pretty much failed over the past decade to hit its inflation target of 2%.

    Now, I understand that capacity constraints and resource shortages due to the effects of the coronavirus crisis can lead to higher prices for those products and services so affected. But, as Yves notes, this is not the same as broad-based inflation.

    IMNSHO, the only way to bring back our economy is through fiscal policy that puts enough purchasing power in the hands of the 90% to bring back the aggregate demand that will be motivate businesses to reopen so they can sell their products and services.

    A Jobs Guarantee with a supplementary UBI would be the best way to go. YMMV.

    1. JBird4049

      From my limited understanding of economics everything you have said is true, but too many economists refuse to accept MMT. Too many appear to question any kind of Keynesianism also.

      Further, since modern economics as taught in college nowdays and blathered all over media was created at least partly to kill New Deal thinking, which is does by creating economic ideas that work on paper, not in real life, but is accepted as true because it does work on paper. Paper over reality. And it so conveniently favors the wealthy.

      Friedman monetarism is part of the successful effort to profitably warp perceptions, deny reality, empower the powerful and crush the masses. The project has worked successfully since at least the 1950s and I think too many are caught up in those beautiful economic theorems to noticed that reality has noticed this.

      1. John Zelnicker

        April 25, 2020 at 6:12 pm

        Quite right. Especially the part about the use of monetarism to support the wealthy and suppress the masses.

        In regards to the economic models with beautiful mathematics, Lars P. Syll, the Swedish economics professor, regularly does a thorough debunking of their usefulness.

    2. eg

      Thank you, John — Blanchard’s bit about sovereign debt ratios gives the game away. He hasn’t the slightest clue what he is talking about, and the net effect is to reinforce the framing that leads to inanity like austerity.


  17. attila the hun

    The Peter G. Peterson Foundation, was founded by the late billionaire Peter G. Peterson, former Chairman of the Blackstone Group. The Peterson Foundation, according to Wikapedia is “dedicated to promoting fiscal austerity.” That is fiscal austerity for the masses. Read the research that comes out of that group with their purpose in mind.

  18. Sound of the Suburbs

    Do you remember how bad it was in the 1970s?
    Oh yeah, that Keynesian, demand side economics was terrible.

    Do you remember how bad it was in the 1930s?
    No, I wasn’t even alive then.
    They couldn’t remember the problems with neoclassical, supply side economics.

    It’s in the past, let’s go back and have a look.
    The 1920s roared with debt based consumption and speculation until it all tipped over into the debt deflation of the Great Depression. No one realised the problems that were building up in the economy as they used an economics that doesn’t look at private debt, neoclassical economics.
    The money creation of bank credit was making the economy boom, and debt was building up in the economy leading to a financial crisis in 1929.
    The economy boomed, the markets soared and nearly everyone was making lots of money.
    The neoclassical economists couldn’t see a cloud on the horizon.
    “Stocks have reached what looks like a permanently high plateau.” Irving Fisher 1929.
    At 18 mins.

    Before 2008.
    The money creation of bank credit was making the economy boom, and debt was building up in the economy leading to a financial crisis in 2008.
    The economy boomed, the markets soared and nearly everyone was making lots of money.
    The neoclassical economists couldn’t see a cloud on the horizon, e.g. the FED, IMF and OECD.

    They couldn’t remember the problems with neoclassical, supply side economics.

    We saved the banks this time, which did stop another Great Depression.
    The Great Depression cleared down the debt, but we haven’t done that.
    It’s still there and the repayments on that debt act as a drag on growth.
    In fact, the central bankers have eased monetary policy to add to the debt.
    There is no way out that way.

    Richard Koo had studied what had happened in Japan and knew the same would happen in the West after 2008. He explains the processes at work in the Japanese economy since the 1990s, which are at now at work throughout the global economy.
    Debt repayments to banks destroy money, this is the problem.
    This is what caused the debt deflation of the Great Depression, which Japan has been fighting since 1991.

    Debt deflation is the problem on the horizon.
    If Government over compensate with too much Government created money then you will get inflation.

    Problem solving involves two steps.
    1) Understand the problem
    2) Find a solution

    Adair Turner took over at the FSA when Lehman Brothers collapsed and this gave him the incentive to find out what was going on.
    Adair Turner has looked at the situation prior to the crisis where advanced economies were growing by 4 – 5%, but the debt was rising at 10 – 15%.
    This always was an unsustainable growth model; it had no long term future.
    After 2008, the emerging markets adopted the unsustainable growth model and they too have now reached the end of the line.

    That’s good enough for step one.
    What solution has Adair come up with?
    His answer is Government created money.
    The money supply ≈ public debt + private debt
    You can maintain the money supply while paying down the debt.
    Excellent, that sounds more like it.
    Public debt and private debt are way too high already.

    As Adair had realised already, you can fine tune Government money creation to get it right.

  19. FedUpPleb

    When house prices inflation goes through the roof over 40 years,
    but wage inflation is stagnant over the same period,
    what kind of regime have we been living in to date? Inflationary or deflationary?

    Does it even make sense to talk of a general regime, outside of the oil crisis?

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