Inflation: could covid-19 cause prices to rise?

Summary

The video script delves into the complexities of inflation, its impact on the economy, and the challenges faced by central banks in managing it. It discusses the traditional understanding of inflation as too much money chasing too few goods and the role of central banks in controlling it. The script highlights the unexpected low inflation rates despite high employment, the failure of the Phillips Curve to predict inflation accurately, and the economic conundrums that have arisen as a result. It also explores various theories for the stagnation of inflation, including the influence of globalization and the behavior of firms and consumers. Finally, the script suggests that the pandemic's disruption and the unprecedented cooperation between central banks and governments might offer a path to revive inflation and stimulate the global economy.

Takeaways

• 📈 Inflation is the rise in prices across the economy and has been historically managed by central banks like the Federal Reserve to maintain economic stability.
• 🔍 Central banks have traditionally believed that controlling inflation was a sign of a stable economy, but this belief has been challenged in recent years.
• 🌐 Despite high employment rates, which typically drive inflation up, inflation has remained low in many developed countries, puzzling economists and policymakers.
• 💵 The traditional view of inflation is that it results from too much money chasing too few goods, often triggered by central banks printing money or keeping interest rates low.
• 📉 High and volatile inflation can disrupt economic planning and financial transactions, leading to a breakdown in long-term borrowing in severe cases.
• 🎯 Central banks typically aim to keep inflation around 2%, using tools like interest rate adjustments to curb inflationary pressures.
• 📊 The Phillips Curve, introduced by economist A.W. Phillips, was a historical tool used by central banks to predict inflation based on the relationship between wage growth and unemployment.
• 🛑 The 'Volcker Shock' of the 1980s, where interest rates were raised to 20%, successfully curbed high inflation but at the cost of mass unemployment.
• 🔄 The global financial crisis and subsequent low unemployment rates have not followed the traditional Phillips Curve model, leading to a reevaluation of inflation dynamics.
• 🌐 Globalization and the influx of cheap imports have contributed to keeping inflation low, challenging central banks' ability to respond with interest rate adjustments.
• 💼 The pandemic has disrupted economic norms, but the unprecedented cooperation between central banks and governments, including monetary easing and stimulus packages, may help revive inflation and the economy.

Q & A

What is the traditional explanation for inflation?

The traditional explanation for inflation is that it occurs when there is too much money chasing too few goods. This can be a result of a central bank printing too much money or keeping interest rates low, which makes borrowing money very easy.

Why is inflation a concern for central banks?

Inflation is a concern for central banks because when it is high and volatile, it can damage the capitalist system by making planning and borrowing difficult, as there is uncertainty about the future value of money.

What is the Phillips Curve and how was it used by central banks?

The Phillips Curve is a graphical representation of the relationship between wage inflation and unemployment, observed by A.W. Phillips. Central banks used this curve to predict inflation, as it suggested that when employment was high and wages were rising, it would lead to price increases.

What drastic measure did Paul Volcker take to curb inflation in the 1980s?

Paul Volcker, the head of the Federal Reserve, raised interest rates to a record 20%, a measure known as the 'Volcker Shock,' which successfully brought inflation down by the 1980s.

Why did the traditional understanding of inflation seem to fail in the past decade?

The traditional understanding of inflation failed because, despite high employment rates which normally cause inflation to rise, inflation remained mysteriously low across much of the rich world, baffling economists and politicians.

What is one theory explaining the recent phenomenon of low inflation despite high employment?

One theory is that central banks have kept inflation low for so long that people no longer expect it to rise, even during a jobs boom, leading firms to be more reluctant to raise their prices or wages.

How has globalization potentially contributed to low inflation?

Globalization has potentially contributed to low inflation by leading to an influx of cheap imports, which has helped keep prices low and made it more difficult for firms to raise their prices.

What was the impact of the pandemic on the relationship between central banks and governments?

The pandemic led to greater cooperation between central banks and governments, with central banks printing money and governments offering stimulus packages to ensure that people could spend it, without putting upward pressure on interest rates.

What is the potential outcome of the cooperation between central banks and governments during the pandemic for inflation?

The cooperation could be enough to not only pick inflation up off the floor but also help repair the global economy by providing a powerful stimulant to the economy without causing inflation to rise excessively.

Why did firms not raise wages much during the economic recovery after the financial crisis?

Firms did not raise wages much during the recovery because they did not want to cut wages much during the financial crisis to protect worker morale, which in turn slowed inflation.

How did the global financial crisis of 2007-2009 affect inflation?

Surprisingly, the global financial crisis of 2007-2009 did not cause inflation to fall very far, despite mass unemployment in America, which was contrary to the expectations based on the Phillips Curve theory.