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(Kitco News) The view that inflation is temporary could lead to severe consequences for the US economy, Deutsche Bank warned in a report.
“The result of the delay will be more disruption to economic and financial activity than would be the case when the Fed finally acts,” wrote Deutsche’s chief economist, David Volkert Landau et al. “This in turn could trigger a major recession and trigger a cascade of financial distress around the world, particularly in emerging markets.”
Deutsche Bank disagrees with the Federal Reserve’s expectations that the sharp rise in inflation that the US economy will experience this year will be temporary, mainly due to fundamental effects.
“We are witnessing the most significant shift in global macro policy since the Reagan/Volcker axis 40 years ago. Financial pumping is now ‘off the charts’ at the same time that the Fed’s modus operandi has shifted to tolerate higher inflation. Never before. We’ve seen such This is a coordinated expansionary fiscal and monetary policy. This will continue with production moving above potential. That is why it is different this time for inflation.” “The effects can be devastating, particularly for the most vulnerable groups in society.”
The world is leaving its previous low inflationary environment. This shift has been accelerated by the massive monetary response to the coronavirus pandemic.
“It may take a year longer to 2023, but inflation will re-emerge. While it is impressive that this patience is due to the fact that the Fed’s priorities are geared towards social goals, neglect of inflation leaves global economies standing on a time bomb., Folkerts-Landau said. Sovereign debt soared to unimaginable levels a decade ago, as major industrial nations crossed the red line levels of 100% of GDP.
This crisis has been a completely different beast, mainly because of the amount of stimulus that has been introduced into the economy. Congress has passed more than $5 trillion in pandemic-related stimulus so far. On top of that, the Federal Reserve nearly doubled its balance sheet to nearly $8 trillion.
“There is a stark difference between today’s response and the response to previous financial meltdowns as current stimulus dwarfs the response to the crises in 2008 and 1930. The current fiscal stimulus is more comparable to what we saw during World War II. After that, the US deficit remained between 15-30 % for four years. While there are many important differences between the pandemic and World War II, we note that annual inflation was 8.4%, 14.6% and 7.7% in 1946, 1947 and 1948 after the economy returned to normal and pent-up demand was released, economists said at Deutsche Bank, which is why it’s different this time for inflation.
Deutsche’s team has suggested that the type of inflation coming could be similar to what happened in the 1970s – a decade that saw prices grow on average 7% and even double digits during certain times.
At the time, then-Fed Chairman Paul Volcker struggled with high inflation with a sharp rise in interest rates, which led to a recession. The report warned that this may be in store for the United States this time as well.
“Already, many sources of price hikes are seeping into the US economy. Even if they are temporary on paper, they may fuel expectations just as they did in the 1970s,” the report said. “The danger, then, is that even if it’s only incorporated for a few months, it can be difficult to contain, especially with very high stimulation.”
In the face of all this, the Fed has promised to keep its monetary policy loose until it reaches its full employment and inflation targets. The German bank added that while the US central bank remains patient in light of rising inflation, it may miss the opportunity to act in time.
“The result of the delay will be greater disruption to economic and financial activity than could be the case when the Federal Reserve finally acts. This, in turn, could trigger a major recession and set off a cascade of financial distress around the world, particularly in emerging markets.” “Few still remember how our societies and economies were threatened by high inflation 50 years ago. The simplest laws of economics, those that have stood the test of time for a thousand years, have not been suspended.”
Meanwhile, US Treasury Secretary Janet Yellen said President Joe Biden’s $4 trillion spending plan should go ahead even if it leads to higher inflation that could continue into next year and lead to higher interest rates.
“If we end up with a slightly higher interest rate environment, that would actually be an addition to the community’s view and the Fed’s view,” Yellen told Bloomberg on Sunday.
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