There is no need to be afraid of inflation

Fear and concern about inflation is unfounded. The long-term consequences of central bank policy are probably to be seen in other areas, but they can have just as many consequences as permanently high inflation.

Once again, the fear of inflation is on the rise. This time, as repeatedly in recent years, the triggers are the central banks‘ major rescue programmes. All over the world, interest rates were cut, liquidity was pumped into the markets and assets were bought. In the Corona crisis, these programs in the larger countries generally far exceeded the trillion mark. An end is not in sight.

The enormous commitment of central banks is not a new phenomenon. Already after the financial and debt crisis, central banks saved the global economy from greater damage with programmes of this kind. Even then, there were always phases with greater concern about a rapid rise in inflation, but inflation did not actually occur in the last 10 years.

As a rule, the protagonists of the fear of inflation have a scenario like the one in Germany in the 1920s in mind. During this period, the German government (and not independent central banks) printed money to meet its obligations. The money supply in Germany has grown very strongly and has completely decoupled itself from economic output. The result was a complete loss of confidence in the currency among the population and ultimately hyperinflation. In my view, such a scenario is hardly possible today. Although money supply growth has accelerated somewhat recently, it is far from decoupling from the economic fundamentals. Moreover, there is no evidence of capital flight from the euro area and the exchange rate is stable. Such a chain of effects as a trigger for a sustained acceleration of inflation can be ruled out.

Let us now turn to the real economic aspects. The current monetary policy programmes of the central banks secure the supply of liquidity to the real economy by the banks, but not the banks directly. Due to the economic standstill, the demand for liquidity and, consequently, the demand for credit has risen very sharply. The commercial banks, together with the development banks, are fulfilling their obligations and have increased lending substantially. As a result, the growth of the money supply has also accelerated somewhat. This could actually lay the foundation for a higher inflation dynamic.

Although the demand for credit has increased, the loans are only needed as a liquidity substitute. Hardly any investments will be made. Instead, business investment activity should remain rather very restrained in the coming years. The Corona crisis was a supply shock at the beginning, but has since turned into a demand shock. Companies are suddenly faced with much weaker demand, which should continue for some time to come, as the economic and social constraints cannot be completely eased. In addition, the pandemic could change living and consumption habits, which would at the very least result in a change and possibly also lower demand.

The massive promises of aid by central banks and governments have the declared aim that there should initially only be a small number of insolvencies. This will ensure that capacity does not diminish. This means that demand is falling globally, but supply is only declining marginally.

However, global capacities were already more than sufficient before the COVID-19 crisis. At least there was no demand-driven inflation in recent years. So in the coming years the global economy should rather have to struggle with the overcapacities. This restricts the scope for price increases and the incentive to invest is further diminishing.

The support measures taken by central banks and governments thus tend to have a disinflationary effect, i.e. in the direction of low inflation, rather than ensuring high inflationary momentum. Certainly, in a few years‘ time, when the global economy has found a new balance between supply and demand, the current policy mix could have an inflationary effect. But by then, a large part of the current programmes will have been scaled back.

So there is no need to worry about inflation, but rather about a lasting environment of very low inflation. In other words, the kind of environment we’ve seen over the last 10 years. But the dangers that arise from this are not insignificant.

The money that the central banks pump into the markets does not affect the prices of goods, but it does affect prices in the financial markets all the more. The financial markets are thus increasingly decoupling themselves from the real economy. In this way, the central banks could lay the foundation for a global economic crisis. Namely when the soaring asset prices have reached a level that is no longer sustainable. In this context, the tulip crisis and the collapse of Wall Street and subsequently the global economic crisis in the 1920s should be recalled.

In addition, the current central banking system itself could come under threat. The central task of central banks is to ensure a moderate inflation environment. However, if inflation is not an issue for another 10 years, the question could arise as to whether central banks with all their power are actually needed. This may well be politically opportune. It should be remembered, however, that it is actually only public confidence and central banks that have brought about a low inflation environment and low volatility on the financial markets in recent decades, which has been an important and essential contribution to the increase in prosperity in the world.

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