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You won’t like what comes after inflation…

By Eduardo Porter

After curbing inflation, then what?

We’ve lost sight of that particular question over the last year, caught up in the “drama” of a price spiral unseen in most of our lifetimes. But whether the Fed has crashed the economy into recession or still manages to engineer a soft landing, we are likely to emerge from this historic episode facing a difficult economic landscape, which will present problems for which we will not have immediate solutions. solutions.

We seem to be on the way out. Investors in bond markets expect inflation to moderate in a year or two. Despite the turmoil in China, global supply chains appear to be recovering from the shock of the pandemic. The Fed is raising interest rates quite aggressively, and the last vestiges of massive fiscal stimulus cycles are fading, reducing personal savings. Job growth is slowing.

The quagmire of the “new normal”

The problem is that the new normal will lead us back to a version of the hole we were in earlier: a quagmire of a shrinking workforce and low investment, stagnant wages and rampant inequality that stifled prosperity for years.

The critical economic question – where does growth come from? – will become even more difficult if energy remains expensive and China stops growing like an emerging market and starts to slow like a developed one.

Unlike inflationary crises—a problem that the Federal Reserve and other central banks have learned how to deal with by raising their key interest rate—the post-inflationary scenario is difficult to diagnose, let alone read correctly.

Aging is shrinking the size of the labor force, increasing dependency ratios not only in rich countries, but also in China.

This dynamic is at the heart of many of our misfortunes, which hold back economic growth. It is the main driver of the so-called “secular stagnation”, which before Covid-19 was considered the main economic challenge of our time: a combination of high savings and lackluster investment which had led us to stubbornly low growth, together with stubbornly low inflation and stubbornly low real interest rates.

Stagnation seems likely to stay with us. Olivier Blanchard, former chief economist at the International Monetary Fund, emphasizes how workers who expect to spend more of their longer lives in retirement are spending less and less and saving more and more. Lower fertility rates push in the same direction, reducing the future labor force relative to the total retirees.

This puzzle would be difficult to solve even if everyone agreed on its basic features. By trying – as it did – to smooth the economy by buying long-term debt, the Fed was falling outside – below – its inflation targets for years. Growth has consistently disappointed for a decade since the financial crisis and interest rates have remained rock bottom.

Some economists have suggested the solution is much more government spending, which could help boost demand. This argument is unlikely to continue to be widely made, since the large fiscal stimulus packages of 2020 and 2021 contributed to a runaway inflation explosion not seen in four decades.


Moreover, there is no unanimity regarding the diagnosis. Other related factors also play a role: income inequality likely reduced spending and increased savings, as did corporate concentration. An increased perception of risk – due to pandemics, geopolitical upheavals and lengthening supply chains, as well as regulatory uncertainty – has also likely affected investment. And de-globalization, if indeed it continues as a trend, will likely further push prices up and economic growth down.

People can’t even agree on how aging will move in the future. Some economists at the IMF argue that just as the demographic bubble produced by the boomer generation kept inflation relatively low for 40 years as they worked and saved for retirement, it will now push inflation higher as they themselves leave the workforce and will spend what they have been saving for years in their “nest”.

Charles Goodhart of the London School of Economics points roughly in this direction. The period of low inflation since about 1980 was a historical outlier, he says, mainly because of the growth of the labor pool and mainly because of the integration of China’s huge labor force into global markets. This demographic dynamic is now reversing – bringing low growth and higher prices.

Pensions and productivity

So what do policy makers do with all this? A wild card that could soften the blow is raising the retirement age. This policy, however, is not easy (see Macron’s political woes in France). Faster productivity growth would help. Somewhat unexpectedly, MIT’s Daron Acemoglu and Pascual Restrepo found that societies that aged faster experienced higher growth, perhaps due to more investment in automation.

As measured, however, productivity growth has been far from spectacular. The rise seen during the pandemic looks unlikely to be sustained, says John Fernald of the Federal Reserve’s San Francisco branch.

As exciting as CRISPR and Tesla-style innovations are, technological progress seems somewhat “stuck,” at least compared to the more distant past.

Source: Bloomberg

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