Most economists failed to predict this new wave of inflation. That cannot be denied. And it is important to investigate the causes of this blindness. Of course, this forecast error, suddenly, did not come as a surprise to some conservatives who have been complaining for more than 40 years about liquidity injections and state intervention in the economy. But you don’t have to be a genius to know that the eternal warnings about inflation by some, during the Great Moderation, were more a matter of dogma than clairvoyance.
Since the world is a world, the end of the world is being preached. Thousands of years have passed and the world is still turning. However, one day the prophecy will surely be fulfilled. That does not mean, of course, that we now have to take seriously the religious madman in the square. We well know that, as in the case of Peter and the Wolf, not all cries of inflation have been credible in the past. In many cases, “inflation” (real, fictitious or probable) has been a political banner against statism. Inflation has been the wolf of many political sectors. And we know that the concept has been abused a lot for political reasons. So, for more than 40 years, those cries of “inflation” have not been taken very seriously. However, the fearsome wolf finally arrived. Now the wolf is among us and does not want to leave.
Now, forecasting is not easy. Rational forecasters typically rely on probabilities and models to make their forecasts. That is, the future is predicted using common patterns in the past. This is not the worst of methods. But it is not a perfect method. In fact, it works in most cases. Nevertheless, It must be taken into account that the information used to build the models is not all the relevant information. And the time frame used is not always long enough.
For example. If we use a span of 15 years to judge events, surely events that have not occurred in 40 years will take us by surprise. A pandemic, for example, is not a very frequent event. You could say we’ve had one every 70 years. Obviously, the world was not prepared for a pandemic. So, we faced it very awkwardly.
At the economic level, the monetary authorities studied the situation and applied the same medicine that was applied during the last crisis. In other words, the restrictions and confinement generated a deflationary picture (in appearance) very similar to the one generated during the 2008 crisis. And, to avoid an economic collapse, a stimulus rescue plan was implemented. The medicine worked. And a collapse was averted. However, the production and distribution chains did not recover to their pre-pandemic levels as expected.
After the credit crisis of 2007-2008, the bailout stimulus did not cause inflation, because the global production and distribution apparatus responded to demand quite efficiently. In other words, the rain of money did not flood the streets, because the drains worked. On this occasion, the rain found the drains clogged. While we were all worried about the drought, we forgot to check the state of the drains. Or, put less metaphorically, worried about deflation, the vulnerabilities of our production and distribution chains were not taken into account. It is obvious that the pandemic served as the catalyst that expelled those vulnerabilities.
With factories closed, ports overcrowded, containers packing, truckers packing, logistics collapsed, and inventories in crisis, the system’s ability to perform was significantly diminished. Rather, it didn’t measure up. But that came out in the heat of battle. Apparently, Almost all of us underestimated the strength of the global system before the pandemic.
The abrupt change in consumption pattern during the pandemic also made analysis and forecasting more difficult.. Due to the confinement situation, the world turned to digital. The consumption of goods increased and the consumption of services decreased. This fall in the consumption of services is very relevant, because the services sector is the most important employer in many countries. Then, the stimuli directed to the services sector were used in the consumption of goods. Which had pretty mixed results. That made the job of the authorities more difficult.
The third aspect worth mentioning here is the labor market. During the pandemic, the labor market registered very peculiar behaviors. People became more demanding to return to the workforce. Which raised wages. And, with more money in the pockets, the demand increases. Here we can highlight the influence of fiscal spending as an additional element in this core. In the beginning, the fiscal side did not always work with the monetary side. But, at a later stage, the tax side made up for lost time with some exaggeration.
However, the monetary authorities faithfully followed their mandate at the time with the stimuli. The US Federal Reserve, for example, did what it had to do. The problem was not applying the remedy at first. The mistake was in not knowing how to brake in time at the end. What is known as “being behind the curve”. Once it became known that inflation would get out of control. The Fed was still insisting on the “transience” of inflation. In this late reaction, was the flaw.
This flaw in analysis and forecasting on the part of the Federal Reserve damaged its credibility. Which affected expectations. Y expectations are very influential, because, very often, they become self-fulfilling prophecies. People, when they think prices are going to go up in the future, often spend more now in anticipation of price increases. That creates inflationary pressures.
The war in Ukraine came as a surprise. Obviously such a senseless invasion was not expected at such an inappropriate time. The war has brought problems and restrictions in the supply of oil, natural gas and food. This adds to the already mentioned problems of the production and distribution chain. What does this mean? It means inflation induced by supply failures.
Considering the particularities of our situation, it is not unreasonable to assume that our problems will not be solved simply by changing monetary policy. Everything seems to indicate that simply raising credit costs will not be enough. Because this inflation is not only a monetary phenomenon. It is (also) related to our current inability to produce and distribute goods and services at the same levels as before.
In a world plagued by conflicts (external and internal), the process of globalization is undergoing a reversal. In other words, inflation is a multifactorial phenomenon. And his solution does not lie solely in money. A more comprehensive approach is required. That is, not everything falls on the shoulders of the Federal Reserve. Governments must also do their part. Are governments taking the necessary policies?
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