Massive stimulus tips inflation scale

money-glitz | Kevin Xu 18 May 2020

Some economists are warning that the explosion in money creation by central banks to shore up coronavirus-battered economies may ultimately translate into inflation or even stagflation if the recovery is slow in the post-coronavirus world, triggering a debate over the economic ramifications of unprecedented policy easing.

The International Monetary Fund's policy tracker shows that fiscal measures have amounted to about US$8 trillion (HK$62.4 trillion) and liquidity injections by central banks amounting to over US$6 trillion, Lesetja Kganyago, Chairman for the International Monetary and Financial Committee, said in April.

However, huge levels of fiscal and monetary stimulus and likely measures to tackle worsening wealth inequality, will start to drive inflation, says Chetan Ahya, chief economist at Morgan Stanley, in a note.

"The near-term disinflationary trend will quickly give way to reflation and then inflation," Ahya says.

"We see the threat of inflation emerging from 2022 and think that inflation will be higher and overshoot the central banks' targets in this cycle. This poses a new risk to the business cycle, and future expansions could also be shorter."

Stephen Roach, an economist at Yale University and former chairman of Morgan Stanley Asia, sketched a future of stagflation in an op-ed in the Financial Times, due to pent-up demand and the disruption of global supply chains.

"Assuming that governments continue to support worker incomes in the meantime, the release of this pent-up demand could spark an inflationary spiral that markets are not expecting," Roach says.

"The anti-China weaponization of supply chains promises to riddle global production systems with bottlenecks. Inflation will not return while the recession deepens. But as recovery takes hold, a new world of fragmented, more expensive supply chains may tell a different story."

In the United States, the Labor Department said last Thursday, another 2.98 million Americans filed for unemployment benefits in the week ending May 9, and export prices retreated 3.3 percent month-on-month in April. This came after Federal Reserve Chairman Jerome Powell warned Wednesday of the threat of a sustained recession in the US due to the coronavirus outbreak, and called for additional fiscal spending, but he denied the option of setting negative interest rates, which President Donald Trump has repeatedly called for and the Bank of England is weighing up.

But economists who do not share the pessimistic views argue that central banks will withdraw easing measures before price movement gets out of hand, and that most of the liquidity could be absorbed by residents and small and medium enterprises who need help.

"At this stage though we see little prospect of inflation, commodity prices are in retreat and will keep inflation low in the coming months. Looking further ahead, the recession is likely to keep inflation under control well into next year given the long lags between growth and prices," says Keith Wade, chief economist and strategist at Schroders, in a report.

"In the long term, the central banks could also start to withdraw the easing. They are not stupid. They will not continue to ease until inflation becomes very strong," says Wang Tao, chief China economist at UBS.

Meanwhile, most of the funds injected are used to sustain the cash flows of residents and SMEs to keep them afloat, so the side effect may not be that large, says Shao Yu, chief economist at Orient Securities (3958).

Pumping a little bit of money will really fuel inflation if the economy is not weak, says Iris Pang, chief economist for Greater China at ING. "But when we are in an expected recession, I don't think that the quantitative easing or negative interest rates is going to fuel inflation in any way."

Even if inflation was to rise, a 3-4 percent inflation rate is not a big threat to the economy, though it is higher than the current consensus of about 2 percent, Shao adds.

He does not foresee runaway inflation, given the excess industrial capacity around the world, plunging oil prices, and relatively stable food prices.

As for stagflation, Wang and Pang do not think that is likely to play out either.

"You can have stagnant growth, but in that case, inflation is not going to be strong, so I think that term is overused," Wang says.

"We have negative GDP growth and a little bit inflation," Pang says. "I think we are going to have recession and deflation, not stagflation."

On the other hand, there are also growing worries that the global economy - including China and the US - is likely to slip into deflation, or a decline in the general price level, in the near term, due to weaker demand, high unemployment, falling oil prices, and a looming recession.

This came as both China and the US reported decelerating consumer price growth in April on a year-on-year basis.

US consumer prices grew by 0.3 percent year-on-year in April, compared to 1.5 percent in March, while the consumer price index in China climbed by 3.3 percent last month from a year before, compared to a 4.3 percent increase in March.

Wang expects China's CPI to average 2.4 percent this year.

The deflation will last in line with the recession in major economies at least for this year, which may further deteriorate with the second wave of infection and another round of trade war, Pang points out.

"Deflation is much worse than inflation," Pang says. "It's very difficult to get out of deflation because deflation and recession go hand in hand."

For the time being, central banks are focusing more on staving off a catastrophic economic collapse than accomplish their inflation targets, Pang and Shao say.

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