Inflation: could covid-19 cause prices to rise?
Summary
TLDRThe 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.
Outlines
📉 The Great Inflation Mystery
This paragraph delves into the complexities of inflation and its unpredictable behavior over the past decade. Central banks, such as the Federal Reserve, have historically managed inflation by maintaining a stable economic environment. However, despite high employment rates, inflation remained stubbornly low, challenging traditional economic theories. The script explains the concept of inflation, its impact on consumer goods, and the traditional belief that an increase in money supply or low-interest rates would lead to higher prices. It also touches on the Phillips Curve, which historically correlated wage growth with unemployment levels to predict inflation, and the extreme measures taken by Paul Volcker to combat high inflation in the 1970s. The paragraph concludes with the acknowledgment of a modern economic conundrum where low unemployment does not translate into higher inflation, indicating a need to unravel the 'great inflation mystery' to stabilize the global economy.
🌐 Globalization and the Phillips Curve's Hiatus
The second paragraph explores the reasons behind the recent stagnation of inflation despite a robust job market and low unemployment rates. It discusses the potential 'death' of the Phillips Curve, which traditionally predicted inflation based on employment levels. The script presents various theories to explain this phenomenon, including the possibility that long-term low inflation has led to a self-fulfilling prophecy where businesses and consumers do not expect prices to rise. Globalization is also highlighted as a factor, with cheap imports keeping inflation in check. The paragraph also touches on the limited tools available to central banks due to historically low interest rates, which restricts their ability to counteract deflationary pressures. It concludes with the unexpected impact of the pandemic, suggesting that government and central bank cooperation, including economic stimulus packages and near-zero interest rates, might serve as a catalyst to revive inflation and mend the global economy.
Mindmap
Keywords
💡Inflation
💡Central Banks
💡Phillips Curve
💡Interest Rates
💡Globalization
💡Economic Uncertainty
💡Recession
💡Monetary Policy
💡Volcker Shock
💡Stimulus Packages
💡Pandemic
Highlights
Inflation's unpredicted behavior over the past decade has challenged traditional economic theories and central banks' strategies.
High employment rates prior to the pandemic did not lead to increased inflation as typically expected.
Central banks' power to influence inflation and the economy may be less than previously believed.
The current economic uncertainty underscores the urgency to understand and address the inflation mystery.
Inflation is traditionally explained by an excess of money chasing limited goods, affecting interest rates and borrowing ease.
High and volatile inflation can severely disrupt economic planning and financial transactions.
Central banks aim to maintain a stable inflation rate of around 2% to avoid economic extremes.
The Phillips Curve, correlating wage growth with unemployment, was a key tool for predicting inflation.
The 'Volcker Shock' of raising interest rates to 20% successfully curbed inflation in the 1980s.
The global financial crisis of 2007-2009 surprisingly did not lead to a significant drop in inflation.
Low unemployment and economic recovery in 2019 did not result in the expected rise in inflation.
Some economists have declared the Phillips Curve obsolete, while others believe it's temporarily inactive.
Persistent low inflation has led to a radical rethink of the factors influencing price stability.
Globalization and cheap imports are suggested as contributors to sustained low inflation rates.
Central banks' limited ability to respond to globalization due to historically low interest rates.
Firms' reluctance to adjust wages during the financial crisis may have contributed to slow inflation recovery.
The pandemic's disruption might unexpectedly aid in raising inflation and stabilizing the economy.
Unprecedented cooperation between central banks and governments during the pandemic could stimulate economic recovery.
Government stimulus packages, in tandem with central banks' monetary policies, may boost inflation back to target levels.
Transcripts
This line tracks the rise and fall of inflation...
...the rate at which prices increase across the economy
For years central banks, like America's Federal Reserve...
...thought they understood why inflation fluctuated...
...and how to keep it steady
Central banks felt that as long as...
...they could keep inflation on an even keel...
...it was probably a sign...
...that they were also keeping the economy on an even keel
But for the past decade inflation hasn't played by the rules
Despite high employment before the pandemic in places like America...
...which normally causes inflation to rise...
...it's been mysteriously low across much of the rich world...
...and central banks seem unable to revive it
Low inflation means that central banks are less powerful...
...than we thought or less powerful than we hoped
This is particularly worrying...
...as the world faces a period of profound economic uncertainty...
...making it more important than ever...
...to solve the great inflation mystery and repair the global economy
Inflation is when prices rise across the economy
It helps explain why a Big Mac cost less than $3 twenty years ago...
...but is nearer $6 today
The traditional explanation is too much money chasing too few goods
According to this logic, if a central bank prints too much money...
...or makes it very easy to borrow money...
...by keeping interest rates low...
...then prices will rise
Events like wars...
...which cause a shortage of goods...
...can also increase prices
So a little bit of inflation doesn't really hurt anybody...
...but when inflation is high and volatile and when it's unexpected...
...it can do a lot of damage to the way a capitalist system runs
It can make planning very difficult
It can make borrowing money and lending money very difficult...
...because you don't know how much you're going to get back...
...and so in countries that suffer high inflation...
...you see a breakdown in long-term borrowing
To avoid extremes of inflation...
...most central banks try to keep it at around 2%
To stop inflation rising, they can increase interest rates...
...making it more expensive for everyone to borrow money...
...which slows the economy and lowers inflation
Predicting when central banks need to intervene to curb inflation...
...used to be pretty straightforward
Thanks in part to observations published in 1958...
...by an economist from New Zealand called A.W. Phillips
He was a tremendously resourceful man
As a schoolchild, for example, he rebuilt a truck from scratch...
...and drove it himself to school, taking his friends along with him
He was also a prisoner of war during the second world war...
...and famously created some secret radios and tea heaters
Phillips observed that wages in Britain...
...tended to rise faster if employment was high
He plotted the relationship between salary rates-of-change...
...and unemployment levels on a graph...
...to produce what is known as the "Phillips Curve"
The Phillips Curve was used by central banks to help predict inflation
As, if lots of people were in work and wages were rising...
...it tended to lead to price increases
If unemployment is low and wages are therefore rising faster...
...that puts upward pressure on costs...
...and firms will feel confident passing...
...those higher costs on into higher prices...
...because the economy is presumably doing quite well
The opposite is also true
When the economy is weak and unemployment is high...
...wages stop rising...
...and firms can’t raise prices much without losing customers
This theory was pushed to the extreme in the 1970s
A spike in the price of oil and overspending to fund the Vietnam war...
...meant that inflation was rising rapidly in America
So Paul Volcker, the head of the Federal Reserve...
...raised interest rates to a record 20%
This huge hike in interest was known as the "Volcker Shock"
And brought inflation down by the 1980s
Labour leaders are increasingly speaking out...
...about the credit-crunch policies of Mr Volcker's Federal Reserve
It created mass unemployment in the US
But it did ultimately have the effect of curbing inflation...
...and as a result, inflation did come down from double digits
But the idea that ups and downs in employment...
...explained changes in inflation, didn't last...
...giving rise to one of the great economic conundrums...
...of the modern world
The signs were everywhere
But now it's official...
...we are in a recession
We received yet another round of alarming employment figures...
...the worst in more than 30 years
The global financial crisis of 2007-2009 caused...
...mass unemployment in America…
...but strangely inflation didn't fall very far
And as the economy recovered...
...and unemployment reached a 50-year low in America in 2019...
...inflation remained mysteriously low...
...baffling economists and politicians alike
Some economists declared that the Phillips Curve was dead
I think a more mainstream view was that it was merely hibernating
This mystery of low inflation led to....
...a radical rethink about what was causing prices to stagnate
One explanation is that central banks have kept inflation low for so long...
...that people no longer expect inflation to rise...
...even in a jobs boom
And firms are more reluctant to raise their prices or wages....
...if they don’t expect anyone else to do the same
Another theory is that globalisation has helped keep prices low...
...because it’s led to an influx of cheap imports
Central banks have run out of room to cope with globalisation...
...because interest rates have been so low since the global financial crisis
And so if you do get downward pressure on prices from...
...for example, manufactured imports from emerging economies...
...central banks don't any more have the room...
...to offset that by allowing other prices to rise faster
Other economists say that because...
...firms didn’t cut wages much during the financial crisis...
...to protect worker morale...
...they didn’t raise wages much during the recovery
And this slowed inflation
Pay and inflation would eventually rise...
...but it would take time
And before inflation had the chance to correct itself...
...the pandemic hit
But an unexpected outcome of the disruption caused by the pandemic…
...might actually help raise inflation and get it back on track
The US Senate has unanimously approved...
...what is essentially $2trn of economic triage
Lowering interest rates almost down to zero
The pandemic has led to far greater co-operation...
...between central banks and governments
As central banks have printed money...
...governments have offered stimulus packages...
...ensuring that people are able to spend it
If governments can borrow and spend...
...in the knowledge...
...that they won't put upward pressure on interest rates...
...because central banks will stop that from happening...
...then that should be quite a powerful stimulant to the economy
This co-operation could...
...not only be enough to pick inflation up off the floor...
...it could also help repair the global economy
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