5 Things You Need to Know About Inflation
Covid and inflation have been hitting the headlines, the former being the source of all evil and the latter one of its frightening consequences, jeopardising the fragile recovery we are experiencing. Worrying about inflation figures is legitimate, yet I would like to share five essential facts in order to put things into perspective and make up his own mind.
1 - The “Two Percent Inflation Target” is no Golden Rule of Economics
Hallelujah! Thanks to the surge in energy prices, inflation has finally reached the 2% annual target set more than two decades ago by wise central bankers. It is welcome, as they have been consistently failing to meet this goal for more than a few months in a row since its inception. The central bankers have finally succeeded hurrah. We should be happy for them and us as citizens, as they act indirectly on our mandate! Should we?
The “Two Percent Target”: and Out Comes the Rabbit.
Central bankers, who claim to have learnt the lessons from the 1970s (times of stagflation, i.e., economic stagnation and high inflation) and the 1930s (struck by recession and deflation), have set the 2% inflation target rate as the best level to encourage investment. The rationale seems to be that it gradually erodes savings without causing a panic, hence making a case for investments.
In other words, they organise the euthanasia of the renters like putting frogs in a pot of hot water. Ultra-liberals, self-called hawks, have fulfilled the dream of Keynes. We do live in a weird world.
Had they been less overworked, well-advised central bankers would have spent more time in books and discovered that the 19th- century average annual inflation rate in the UK and the US was -0.2% (yes, minus 0.2%)[1]. Treasury rates were at 4-5%[2], an incredible spread that in no way slowed down the intense investment flows of the first two industrial revolutions (despite many explosive speculative bubbles).
The 19th- century average annual inflation rate in the UK and the US was -0.2% while Treasury rates were at 4-5% - a spread that did not prevent investors to fuel growth.
Yet, it is not certain that 2% inflation encourages “economic agents” to “invest in the productive forces” rather than save money in safe places. All the more since 90% of the active population is salaried and obsessed with two antagonist achievements: first, frantically consuming imported products (fashion, electronics); at the same time, borrowing at the lowest long-term rate to buy homes.
These two desires advocate for the lowest interest and inflation rates.
2 -? Reality Check: the 2% inflation target has always been a mirage
In any case, assessing the effectiveness of a 2% inflation rate on investment is highly uneasy. Indeed, in the Euro area, “the Governing Council [of the ECB] clarified in 2003 that in the pursuit of price stability it aims to maintain inflation rates below, but close to, 2% over the medium term”[3]. If we assume that “rates below, but close to, 2%” means between 1.8% and 2%, then the inflation rate has been out of this range 94% of the time since January 2003. The Governing Council still missed its self-set goal 83% of the time if we consider the 1.5%-2% range (a liberal interpretation of “below, but close to, 2%”).
The monthly inflation rate has been out of the 1.5-2% range 83% of the time since January 2003 in the Euro area.
3 - Keeping our feet on the ground: technical progress and marketing, not anticipations of inflation, are key drivers
Once again, we must feel sorry for central bankers. Reclused in their ivory towers, they seem to keep on failing to appreciate the pace of innovation and creative marketing prowess. Instead, they reason in a narrow, stable world. Yet, they shall seek the answer to the following plain question: what motivates a consumer today to (re)buy an iPhone? Is it that his or her own is breaking down (in line with the pure utilitarian motivation theory)? Or that its price is likely to rise, so it is time to buy one now or never (case for setting an annual 2% inflation rate target)?
Reality is much more prosaic: Apple finally released the latest version, as it does every year, with much advertising, and consumers rushed in by millions. So did probably central bankers or their assistants.
The textbook case of the iPhone drives us to the following conundrum: the prices of consumer goods have been falling for a long time now because of technical progress, yet they have never been that expensive.
Let us take two typical examples of our way of life, namely cars and phones. Nowadays, buying the mainstream American car model costs roughly one year of median personal income in the USA[4]. In the 1930s, in the context of the Great Depression, one could afford the first mainstream V8 with slightly more than four months of average income[5].
Of course, the equipment between both models is in no way comparable. Yet, the old-school model is no longer available in 2021, even if a consumer wanted it. Such improvements are what we call technical progress.
Thus, analysts would be well advised to distinguish the effects of technical progress on prices from inflation, which only expresses the increase of the nominal level of prices.
Continuing innovation and marketing prowess drive purchasing behaviors, not inflation anticipations.
More recently, the combination of technical progress and state-of-the-art marketing exacerbated this trend: the price of the plain iPhone model in France between 2007 and 2021 rose by 128%[6], while the average wage has only increased by 25%, in line with the Consumer Price Index (CPI).
So how do we overcome the conundrum? We do not. We state it and note that in the years to come, innovations such as 5G, AI and tailored-made digital marketing pave the way for continuing accelerated obsolescence and rising prices.
4 - It’s (unfortunately) all about imported inflation
However, since technological obsolescence and rising prices of the latest versions are intertwined, they, so to speak, offset each other, leading the global Consumer Price Index excluding energy (the ‘core’ CPI) to remain flat.
In Europe and the USA, three main drivers accounted for the variation in prices over the last twenty years, as measured by the CPI:
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In other words, no matter what experts say, the evolution of prices has nothing to do with rational expectations of “economic agents” or other theoretical concepts. Simply old plain imported inflation.
In Europe, growth and inflation will still depend on the volatility of commodity prices and imported consumer products, in the absence of endogenous solid and domestic growth based on innovations and pay rises.
Yet what about headlines about inflation?
5 - Do Not Panic in Front of Headlines
Inflation rates peaked in advanced economies in Q4 2021, reaching record highs:
HCPI[8] monthly data (annual rate of change)
Source: Eurostat
However, we believe that there is no need to make a big deal of monthly inflation figures in the short term. Indeed, if we consider the USA, the country reopened six months before most others, so economic activity rebounded sooner. More importantly, most of the population has no safety net, hence is more reactive to economic fluctuations. For example, people fired in 2020 in the US are rehired with a pay rise, and demand for raw materials increases while supply chains face temporary bottlenecks. In addition, the population is younger, growing, and more dependent on consumer credit than in most other developed countries. Finally, the federal stimulus package, even downsized, will play a role.
These factors, alongside rising commodity prices, translate into rising short-term inflation. As a result, it is now taken for granted that the CPI will exceed 2% in 2022.
With a little more luck, i.e., if central bankers remain accommodative, the average inflation rate over the last ten years may well reach the bottom of the “below, but close to, 2%” goal, after all.
By the way, do not underestimate demography and its effects on economic activity! Pundits shall not explain Japan’s stagnation since the 1990s honestly otherwise. Conversely, the American economic dynamism is partly due to a younger and growing population than Europe, fueled by immigrants eager for the American dream and its promise of happiness through unbridled consumption.
Conclusion: The current rise in inflation is barely the consequence of countries reopening at various paces. We are experiencing a catch-up effect partly fueled by temporary financial support measures to households in many countries – the keyword being?temporary, as governments do their best to prevent inflation sparked by rising payrolls.
Disclaimer: the opinions referenced above are solely those of the author. More precisely, they are among his currently preferred assumptions.
[1] Thomas Piketty, Capital in the Twenty-First Century, p. 171 in the French version
[2] Thomas Piketty, Capital in the Twenty-First Century, p. 325 in the French version
[4] The 2020 Ford F-150 XLT has been the most sold model in the USA in the last years. It starts at USD?34,760. As a benchmark, the US Census Bureau lists the annual real median personal income at USD?35,977 in 2019, with an unemployment rate reaching 4%.
[5] In the early 1930s, the Ford Model B 1932 (V8) was the most sold car (one million per year) and cost USD 495. At that time, the 16th decennial census of the population stated that the average income was USD 1,368. The average unemployment rate in the 1930s was 18%.
[6] Starting price of the iPhone in 2007: EUR?399; starting price of the iPhone 13?(128 Go) in 2021: EUR?909.
[8] The Harmonised Consumer Price Index.
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3 年Bon article Nico Happy new year!