It is too early to talk about stagflation, but inflation risks are rising and therefore central banks need to be very vigilant about tightening monetary policy early if prices rise and global growth slows.
This is what the International Monetary Fund (IMF) stated on Tuesday in its half-yearly World Economic Outlook. Chief economist Gita Gopinath (photo) of the Fund said she thinks it is too early to speak of stagflation, but she acknowledged that here and there in the supply chain there are growing deficits. This is causing additional shocks, which is why imbalances in the global economy are persisting.
Threat of second round effects
The IMF shares the assessment made on Monday by De Nederlandsche Bank: inflation will rise sharply in the coming months and will then fall back to its pre-pandemic level sometime in mid-2022. But Gopinath added that “the inflation risks are upside down.” She therefore called on central banks to intervene if price pressures remain at structurally higher levels. This could be the case, for example, due to energy shocks, but also if rising prices evolve into higher wage demands.
The IMF believes that central banks should anticipate this development. The fund warns that central banks must therefore be “very, very vigilant” about possible second-round effects. The Gopinath Fund says in its report that “a spiral of doubt could dampen private investment and lead to precisely the slower employment recovery that central banks are trying to avoid by not tightening their policies.”
If central banks are successful in dealing with the coming inflation risks, developed economies could fully recover from the pandemic and return to pre-pandemic levels.
DNB also warns of inflation risk
The Dutch Central Bank issued a similar warning in its overview of financial stability on Monday. The inflation risks are increasing and may indeed lead to stagflation in due course.
It also included a warning from DNB economist Ralph Verhoeks that “investors have been taking a lot of risk” and that “may lead to inflation and higher interest rates”. Verhoeks’s answer to the question why investors are taking more and more risks is: “That is because of the low interest rate. It makes it more difficult to achieve a return. That applies to you as a private individual - think of the low interest rate on your savings account. But it also applies to investors.”
“To give an example: bonds are usually a relatively safe investment product. But currently less than 10 percent of the bonds worldwide give a return of 2 percent or more. And almost 30 percent even gives a negative return. That is why investors are looking for alternatives: shares, but also other products. By definition, the higher the expected return, the higher the risk.”
Investors addicted to low interest rates
Verhoeks was asked on the DNB website how this risky behaviour manifests itself. He answered: “You can see that in all kinds of developments. Earlier this year, equity markets reached record highs. Worldwide, 2,300 companies went public so far this year, raising almost 500 billion dollars in capital. That is already considerably more than in the whole of 2020. The market for risky debt securities of companies with low credit ratings is growing. And the market for leveraged loans - loans to companies that already have a lot of debt - also continues to grow. Since the correction in the financial markets in spring 2020, the prices of risky investments have risen almost continuously.”
According to Verhoeks, “investors should take into account that the broad monetary policy of central banks could come to an end and interest rates could rise. They have become addicted to low interest rates over the years.”
Verhoeks’s view is not uncontroversial among investors. Central banks, because of their low interest rate policy, are seen as drivers of the increasing risks taken in the markets. But the DNB, through Verhoeks, said: “When it comes to low interest rates, the European Central Bank (ECB) is often looked at. The ECB has been pushing down interest rates in recent years in order to boost low inflation. But interest rates have been falling worldwide for decades due to structural developments, such as the increase in savings and lower investments.”
| IMF: emerging economies hardest hit |
| The IMF expects the world economy to grow by 5.9 per cent in 2021 and to slow to 4.9 per cent in 2022. Inflation in developed economies is expected to average 2.8 per cent this year and fall to 2.3 per cent in 2022. However, these inflation forecasts have been revised upwards by 1.2 and 0.6 percentage points respectively from April, showing the increasing risk of a new inflation threat. The IMF also noted that even when the pandemic is over, emerging economies would be hit much harder in the long run. They are likely to be almost 10 per cent smaller in 2024 than expected before the pandemic struck. That estimate does not include China. |