The writer is president of Queens’ College at Cambridge University and an advisor to Allianz and Gramercy
It’s not often that I take a very strong stance that goes directly against the market consensus. On the rare occasions in the past that I have done this, it was an uncomfortable feeling at first.
The question is whether my current skepticism about the consensus view of a “Goldilocks-type†scenario for markets in neither too hot nor too cold conditions goes from an outlier to a benchmark for economists and policy makers. The good thing about this is that I won’t mind if I end up getting it wrong, as it would also mean a much lower risk of unnecessary economic and financial disruption.
As a recent Bank of America survey highlights, markets are currently dominated by a consensus based on three fundamental assumptions: high and sustainable global growth; transitory inflation; and always friendly central banks.
By embracing this winning trifecta, investors have pushed equities and corporate bonds higher, anchored government bond markets, and sidelined short sellers who bet on falling prices.
Despite some reservations, I have no serious objection to the idea that growth will be robust in the world’s largest economic regions – China, the EU and the United States.
Indeed, I am more optimistic about the prospects for European growth than I have been for a very long time. I also agree that systemically important central banks will maintain ultra-accommodative monetary policies for quite a while. Whether justified (in the case of the European Central Bank) or not (in the case of the US Federal Reserve), they have invested too much of their reputation and their thinking in uber-stimulus to risk a premature easing of policy. monetary accelerator.
However, I am very concerned about the widely held belief that the current rise in inflation will be transient. Just because I’m denying that the two influences on current data will be reversed – comparisons with a weak base last year and some temporary mismatches between supply and demand.
Rather, it is because of all the evidence on the ground of structural changes in supply at a time when aggregate demand will remain robust.
This is noticeable in the functioning of the labor market, with uncertainty related to skills mismatches driving up wages. Labor supply could also be affected by a different propensity to work in the aftermath of the pandemic. In addition, supply chains, inventory management and transportation are undergoing constant change.
Then there are the typical lags. Not having lived a period of inflation for some time, it is possible that some investors appreciate two historical dynamics too little.
First, apparently one-off price increases can trickle down through the system. Second, a rise in inflation can be persistent, starting with raw materials and factory gate prices and ending up in consumer prices and wages.
To be clear, I don’t expect a return to 1970s inflation. But we have to respect the possibility of a shock to a financial system that has been conditioned and wired for the persistence of lower inflation. and more stable.
All of this leads to another complication. If such concerns were to be confirmed over the next few quarters – and this will take time as central banks are likely to extend the period that defines the ‘transitional’ – it would raise doubts about the other two elements of the market consensus on a high growth and friendly central banks.
With the Fed shifting its approach to monetary policy to depend on the results of economic data rather than the traditional forecast-based approach, it will likely be very late in adjusting its strategy if its transitory inflation call does not hold up. not materialize.
Late slamming of the brakes, rather than releasing the accelerator early, would greatly increase the risk of an unnecessary economic recession.
Indeed, this is the strong warning message that emerges from even the most cursory reading in the history of the policy mistakes of modern central banks. It also risks disrupting financial stability and further undermining growth. And that is if market crashes do not precede policy error.
The oft-repeated assertion by central banks that inflation will be “transient” sets aside the much-needed exploration of what is going on in both price dynamics and the functioning of the labor market. The result is a comforting balance with increasingly unstable foundations.
With that comes a growing risk of instability down the road, exposing us all to significant economic and financial damage – damage which, thankfully, can still be avoided if central banks and markets widen their perspective.