Fear not: a bit of inflation is no bad thing
This is a sophisticated presentation. Basically, inflation destroys people's savings, which is a very bad thing, but the writer below points out that other things tend to counteract that. Wages rise and stockmarket values rise.
But she is too optimistic. The principal protection that savers have is rising interest rates on their savings. And if interest rates rose in such a way as to give both a return on capital and an inflation counterbalance, that would be fine.
But with recent negigible interest rates being offered on savings, it is clear that interest rates often do neither of those things. So in practice inflation is a serious robber, hitting mostly small savers, The big fish have their money in the stockmarket, either directly or via index funds
Superannuation offers an "out" for the small saver but many superannuation funds are very poor performers, sometimes even giving negative returns
Concerns about inflation look set to dominate the global economic outlook in 2022.
But despite pandemic related shortages pushing up prices for some things like furniture, cars and fuel, the global inflation bogey man is more imagined than real, at this stage.
Financial markets, of course, love nothing more than a general fret-fest about rising prices. What investors are really scared about, however, is not that prices will rise, per se, but that they’ll rise either faster or slower than they’ve factored into their models for valuing shares.
For example, Americans found out on Friday they are facing the highest rate of consumer price inflation since 1982. Prices rose 6.8 per cent over the year to November, driven by higher fuel, food and housing prices. But sharemarkets rallied on the news, as it was in line with their expectations.
Workers, too, commonly fear inflation. Frustration with the rising “cost of living” is a perennial election issue. But again, if they stopped to think about it, it’s not actually inflation that workers fear, but that their wages might not rise fast enough to keep them ahead of the rising cost of living.
Of course, if inflation was such a terrible thing in and of itself, you’d expect governments would try to eradicate it altogether – to keep prices absolutely stable. But they don’t.
In fact, making sure that economies generate a bit of inflation is the explicit goal of central banks around the world. Our Reserve Bank, for example, has an explicit target to keep consumer prices rising at between 2 and 3 per cent on average, over time.
If inflation runs too high, you can be sure they’ll jack up interest rates to cool activity and prices. But if inflation dips too low – as it has in recent times - they’ll also intervene to cut lending rates to ensure people borrow and spend more to push up prices again. Importantly, they’ll also look through any temporary swings in prices and be guided by underlying trends.
I remember once asking a central banker why they didn’t just aim to keep prices stable. Why is inflation necessary at all?
The answer was essentially that a little bit of inflation is better than the alternative: of deflation. Deflation – a phenomenon where prices fall over time - is unambiguously bad.
When people think prices will be cheaper tomorrow, they will delay making purchases, leading to a widespread “consumer strike” which is bad for the economy.
Far better, then, to err on the side of running things too hot, than too cold.
A little bit of inflation also helps to lubricate the wheels of capitalism in various ways.
Let me explain.
If prices are not rising, it can be very noticeable when a company decides to lift prices for the goods or services they provide. If they face supply disruptions which increase their costs, however, companies may need to lift prices to maintain profitability. The alternative, if they can’t increase prices, could be to lay off workers or otherwise cut their wages bill.
So, an environment OF rising prices can help to provide the cover needed for companies to pass on higher costs to survive.
A bit of inflation can also help companies straining to reduce their wages bill by simply lifting worker wages by less than rising prices – i.e. deliver a real pay cut. That’s not great for workers, but nor is losing their job instead.
For borrowers, inflation can also be beneficial.
As we’re about to find out on Thursday in the mid-year budget update, the Australian government has accumulated significant debts during COVID.
It’s ok. We’ve done it before. And we’ll no doubt do it again. The answer to high levels of debt, historically, has been to simply let an expanding economy and rising inflation “inflate” away the real value of the debt incurred. That is, we should pursue policy settings which help the economy and prices to grow so fast, that the debt is worth less, in relative terms, tomorrow than it is today.
Mortgage holders also benefit if rising inflation pushes wages higher, reducing the size of their debt relative to their income.
Before COVID, of course, it had become clear workers lacked the degree of bargaining power they once had to push for higher wages, whether due to declining rates of unionisation, the rise of labour-replacing technologies or more competition from cheaper offshore workers.
But during COVID, I have observed a noticeable shift in thinking from our central bank to be even more determined to ensure workers get the pay rises they are due before interest rates are returned to more normal levels.
‘Remarkable’ recovery not enough to bring budget back to health
As governor Phil Lowe said on Tuesday, future interest rate rises “will require the labour market to be tight enough to generate wages growth that is materially higher than it is currently”. Furthermore: “This is likely to take some time.” Get it?
Our Reserve Bank won’t be lifting official interest rates until it is confident workers are enjoying the sorts of pay rises that would also assist in meeting higher mortgage repayments.
And as we return to life pre-pandemic, that might still be some time away. You can relax about inflation for now.
Post a Comment
All comments containing Chinese characters will not be published as I do not understand them