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Inflation may fall lower than we all think

Planners must consider multiple outcomes, not just higher inflation: GBain
In Practice

With most economists predicting that inflation will be higher in the coming decade than the past, new analysis from Bain & Company suggests that the normal level of inflation in the 2020s may be lower than that currently feared, and financial planners shouldn’t assume that inflation will remain high.

 

The Reserve Bank of Australia forecasts inflation will peak around 7 per cent in the second half of this year.  Reflecting inflationary fears, the yield on 10-year Australian government bonds has blown out to 4 per cent for the first time since 2014. Government bond yields globally have surged in June on fears inflation in developed countries will hit double digits.

 

However, while many economists predict inflation will stay high in coming years, new analysis from Bain & Company suggests inflation may fall back, and financial planners should keep this in mind.
 
“At present, the range of possible economic outcomes is so wide that strategy planners should consider scenarios in which inflation is lower as well as higher,” according to Austin Kimson, vice president, macro trends group at Bain & Company.

“We believe inflationary pressures are likely to increase in the 2020s due to a variety of macro forces, including demographics and post-globalisation …. But higher inflationary pressures may not produce higher inflation rates. [Monetary] policy will play a large role in determining price levels,” says Kimson.

He believes the US Federal Reserve may adopt new monetary policy measures which are more focused on achieving lower price levels, diverging from monetary policy settings in recent years which has targeted economic growth.

“Under such a regime, we could see longer-term trend inflation (that is, the new normal level of inflation) that is as low as or even lower than it has been in recent years,” says Kimson. 

  • Monetary policy rethink on the cards

    Just as the global financial crisis (GFC) forced a substantial rethink of the nature of banking and financial regulation, the great inflationary shock of 2021–2022 is likely to prompt central banks to rethink what are the goals of monetary policy, according to Kimson.

     “To a degree, the extent to which a central bank chooses to encourage or discourage inflation is a policy choice. In recent years, the vast deflationary pressure of globalisation, combined with the fear of Japan-style deflation, has largely framed a pro-inflationary bias that’s been implicit in Federal Reserve policy (and that of the other major developed-market central banks) for the better part of a generation.

    “But in a world without the deflationary pressure of globalisation—one still reeling from a memorable inflationary experience—it’s not unreasonable to expect a pivot and refocus on price stability as the Fed’s overriding mandate,” he says.

    Kimson adds that for many years, the US Federal Reserve has not managed to keep inflation anchored to 2 per cent.  “The Fed’s target rate may have consistently hovered around 2 per cent, but actual trend levels have varied by at least 2 percentage points. … The policy regime of the last 30 years actually isn’t (or wasn’t) particularly stable or well anchored at 2 per cent, nor was it notably more effective than past regimes,” said Kimson. The following chart of US price levels back to the 1930s reveals that price levels have been structurally trending higher in recent years. But Kimson says that could reverse and that a low-inflation future “isn’t out of the question” with central banks revert to targeting low prices rather than economic growth.

    Bain & Company’s views are backed by new research from the International Monetary Fund (IMF) which suggests that inflation may not persist and current high level could recede within two years.
    “Our analysis shows that, of all the countries that brought inflation under control, very few later experienced a surge in out-of-control persistent inflation,” says a recent IMF report, The Future of Inflation, by economists Ruchir Agarwal and Miles Kimball.
    “If history is any guide, we will not experience an out-of-control surge in inflation beyond a couple of years into the future,” they say.

    “Our analysis shows that, of all the countries that brought inflation under control, very few later experienced a surge in out-of-control persistent inflation. That is, very few countries have fallen off the wagon after sobering up from high inflation.”




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