Should we fear post-pandemic inflation?

Inflation could well go through a yo-yo effect, as is already happening with other economic indicators.

By Neil Irwin

It’s not just the usual inflation alarmists. Many people now see high inflation lurking around the corner; a world where, in the not-too-distant future, major economies will face upwardly spiraling prices.

There are lots of reasons, however, to think that the possibility of an early 2020s inflation surge is at best a distraction and at worst something that could lead to bad policy today. It risks ignoring an imminent and clear-cut crisis that is mainly deflationary — causing falling prices.

Still, it’s worth considering the concerns of those who see a meaningful chance of the return of inflation. Their story goes like this:

The public health crisis caused by COVID-19 comes to an end, with either a vaccine or more reliable treatments. People rush to stores and restaurants and resume buying, with lots of pent-up demand after months in quarantine. Meanwhile, a wave of shutdowns leaves shortages across the economy: factories that haven’t been producing, crops rotting in fields, international supply chains freezing up as nations turn inward and globalization reverses.

When those trends run head-on into a huge increase in federal deficits and money creation by central banks aimed at containing the economic crisis, too much money will be sloshing around the economy relative to what is being produced, and prices will rise.

It is a cogent story, with versions of it embraced by thoughtful commentators including Charles Goodhart of the London School of Economics and Nouriel Roubini of New York University. Even some who reject it acknowledge that there is an extraordinarily wide range of possibilities for what the world economy will look like down the road, and it would be foolish to rule it out. A former chief economist at the International Monetary Fund, Olivier Blanchard, recently wrote, “I cannot completely dismiss a small probability of high inflation.”

It’s an interesting intellectual parlor game. But it’s less clear if it’s anything more than that — and if it should matter for people making policy today.

“I think trying to predict where inflation is going to be in a few years is a mug’s game,” said Kristin Forbes, an economist at the Massachusetts Institute of Technology and a former official at the U.S. Treasury and the Bank of England. “Policymakers need to be ready for different scenarios. Right now we have a sharp recession and the need to focus on providing support. If things recover faster than expected, we know how to deal with that. If things don’t recover, that’s a harder situation.”

While shortages and price spikes have been seen with a handful of goods, particularly meat and personal protective gear, there is a glut of most everything else that is driving prices down. And mass unemployment means that wage growth will most likely be weak or nonexistent for the foreseeable future, as workers have no bargaining power to demand raises.

Inflation could well go through a yo-yo effect, as is already happening with other economic indicators. Indeed, by many measures that is the kind of reality that financial markets are pricing in.

Consider the path of oil prices in the years ahead that is implied by the futures market. On Wednesday, a barrel of West Texas Intermediate crude oil for delivery in July cost $32.22. The price for delivery next July is around $37 — implying a 15% surge in the price of oil over the coming year, which would tend to push overall consumer prices upward.

But that still suggests a depressed oil market — a level at which there are widespread bankruptcies among drillers and well below the $61 price at the beginning of the year. Even the most distant available futures contract, for February 2031, last traded at $56.65, implying expectations that a decade from now oil prices will still be below their pre-pandemic level.

You could apply the same logic not only to other commodities but also to service industries that are heavily affected by the pandemic. Hotels, for example, are currently running far below capacity, with only 32% occupancy in the week ended May 16, according to research firm STR. That has led them to slash prices, with average daily rates down 42% from a year earlier.

As public health concerns start to recede, it is plausible that hotels will start filling up and raising their prices in ways that create an apparent surge of inflation even while occupancy remains far below long-term norms. In other words, inflation would be not so much a reflection of an economy that had overheated as an artifact of the strange spring of 2020.

It is easy to see the outlines of a predicament for the Federal Reserve in the next few years. There could easily be inflation rates that are well above its 2% target while prices overall are still below pre-pandemic levels. That would suggest that all the problems deflation can create — in particular, making debts more onerous — would still be very much alive, even as the economic headlines pointed to spiking prices.

It certainly could cause pain for American workers if prices for consumer goods rise while wages are stagnant or falling. But it would fundamentally reflect an economy that was starting to heal, not one that had overheated or in which policymakers had flooded the system with too much money.

And that speaks to the irony of the inflation hand-wringing that has emerged in the last few weeks. In many ways, an inflation surge in the early 2020s would be a signal that all the efforts being taken now (to flood the financial system with cash, to prop up smaller businesses and aid unemployed people) had worked — preventing a deflationary spiral akin to what happened in the Great Depression.

Over the last several decades, globalization most likely pulled inflation downward in advanced nations as they imported goods made with cheaper labor in China and other emerging markets. Today, the potential for de-globalization is real, especially as geopolitical tension between the United States and China rises. But such trends tend to play out gradually, not through a rapid spike in prices, barring something like a world war.

In the next few years, if the Fed had to raise interest rates and Congress had to cut budget deficits to stop inflation from settling in at excessive rates, that would reflect an economy that had returned to full health.

So, is inflation on the horizon once the pandemic is contained? Maybe the answer is yes, and maybe it is no. But maybe the best answer is: We should be so lucky.