With inflation persistently undershooting the 2% target over the past decade, economists at Capital Economics have long argued that deflation could be only one recession away. But, because of several factors that made this year’s recession unique, it won’t be the one that tips the economy into deflation. Inflation expectations are already building.
Key quotes
“The pandemic has increased the odds that the US will eventually experience a period of high inflation, principally because we expect the Fed to be less committed to ensuring price stability in the future. The higher public debt burden, slower global labour force growth and the possibility that globalisation will be partly reversed, are additional reasons to expect inflation to gradually rise over the longer-term to 3% or 4%. Any deflationary pressure from technology is likely to be muted, while several unique factors linked to the pandemic mean that the risk of a near-term slide into deflation is low.”
“Because the lockdowns triggered declines in both production and spending, with the latter recovering more quickly than the former, inventories are unusually lean for this stage of the economic cycle, which is putting upward pressure on goods prices. In addition, ongoing physical distancing restrictions have increased costs and reduced supply in many services sectors. As a result, we expect headline inflation to average 2.5% next year, before dropping back to 2.2% in 2022. Core inflation should average 2.3% next year and then edge back down to 2.2% in 2022.”
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