Inflation: could covid-19 cause prices to rise?

The Economist

8 Jan 202107:58

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

00:00

📉 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.

05:00

🌐 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

Inflation refers to the rate at which the general price level of goods and services in an economy is increasing over time. It is a key economic indicator and is central to the video's theme, as it discusses the unexpected behavior of inflation over the past decade. The script mentions that despite high employment, which typically leads to inflation, it remained 'mysteriously low', challenging traditional economic theories.

💡Central Banks

Central banks are the primary monetary authority in a country, responsible for managing monetary policy, including controlling inflation. The script discusses how central banks, such as the Federal Reserve in the U.S., have historically believed they understood inflation and its management. However, the recent behavior of inflation has led to a reevaluation of their strategies and effectiveness.

💡Phillips Curve

The Phillips Curve is an economic concept that illustrates an inverse relationship between unemployment and inflation. The video explains how this curve was used by central banks to predict inflation based on employment levels. However, the script notes that this relationship has not held in recent years, leading to a 'great economic conundrum'.

💡Interest Rates

Interest rates are the cost of borrowing money and are a tool used by central banks to control inflation. The script explains that by increasing interest rates, central banks can make borrowing more expensive, which slows the economy and reduces inflation. The 'Volcker Shock' is an example from the script where high interest rates were used to combat high inflation.

💡Globalization

Globalization is the process of increased interconnectedness and interdependence among countries. The video suggests that globalization has contributed to low inflation by facilitating the influx of cheap imports, which has put downward pressure on prices. This has challenged central banks' ability to manage inflation through traditional monetary policy tools.

💡Economic Uncertainty

Economic uncertainty refers to the unpredictability and instability in economic conditions. The script highlights the current period of 'profound economic uncertainty' and the importance of understanding inflation in order to address it. This uncertainty adds to the complexity of managing inflation and the economy.

💡Recession

A recession is a period of negative economic growth that lasts for at least two consecutive quarters. The script mentions that the world is in a recession, characterized by 'alarming employment figures'. This economic downturn is a critical context for discussing inflation and its management.

💡Monetary Policy

Monetary policy refers to the actions of a central bank to influence economic activity, particularly regarding inflation and interest rates. The video discusses how central banks have traditionally used monetary policy to manage inflation, but recent challenges have led to a 'radical rethink' about the effectiveness of these policies.

💡Volcker Shock

The Volcker Shock refers to the aggressive monetary policy implemented by Paul Volcker, the former chairman of the Federal Reserve, which involved raising interest rates to a record high to combat high inflation in the 1980s. The script uses this term to illustrate a historical example of extreme measures taken to control inflation.

💡Stimulus Packages

Stimulus packages are economic policies enacted by governments to stimulate economic activity during times of economic downturn. The script mentions that governments have offered stimulus packages in response to the pandemic, which, in conjunction with central banks' actions, could potentially revive inflation and the economy.

💡Pandemic

The pandemic refers to the global outbreak of COVID-19, which has had significant economic impacts. The script discusses the disruption caused by the pandemic and suggests that the response to it, including monetary and fiscal policies, might help to increase inflation and stabilize the economy.

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.