Case Against: Loose Labor Markets
Policy makers have worked with a rule of thumb that assumes some kind of trade-off between inflation and unemployment, known as the Phillips Curve.
The idea is that prices will only face sustained upward pressure when the economy is using all its resources –- including labor.
Doubt has been cast on the strength of that link. Still, if there’s any connection at all, then it should ease concerns about inflation. Employment everywhere has slumped, with little prospect of a quick rebound to pre-pandemic levels.
Case for Inflation: Supply Shocks
There’s already evidence that disruptions to supply chains are pushing prices up. In China, for example, food inflation has been accelerating in the last couple of months, and a squeeze on imports because of the pandemic is one reason why.
The long-run risk is that the virus will escalate tensions like the ones behind the U.S.-China trade war. Governments may become more reluctant to rely on other countries for strategic goods, such as masks and medicine or computer chips. They could pressure business to bring manufacturing home, even when it’s more expensive.
“Trade, tech and titans” -- cheap imports, technological advances and corporate giants with the market power to suppress wages -- have been “the driving forces behind the disinflationary trends over the last 30 years,” Morgan Stanley economists wrote. But the same trio also gets blamed for widening inequality, and faces growing political scrutiny that “could create a regime shift in inflation dynamics.”
Case Against: Spare Capacity
The fight against Covid-19 has often been compared with an actual war, the kind of disaster that historically has triggered inflation.
But there’s an important difference. Military conflicts wreck the supply side of the economy, like factories and railway lines, leading to bottlenecks and shortages that push prices up. The coronavirus has left those facilities intact -- even if they’re not being used right now.
In a pandemic, it’s demand that takes the main hit, says Alicia Garcia Herrero, chief Asia Pacific economist with Natixis SA. “Capital is not destroyed or depleted, so it is much easier to end up with excess capacity,” she says. That distinction is one reason she’s “in the deflation camp.”
This story was provided by Bloomberg News.