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Breakingviews

Breakingviews - Review: Picking the turning point in inflation

Pedestrians wearing protective masks make their way amid the coronavirus disease (COVID-19) outbreak at a downtown in Tokyo, Japan June 29, 2020.

LONDON (Reuters Breakingviews) - Inflation has in recent years been like Samuel Beckett’s Godot: much awaited but never turning up. That is about to change, according to economists Charles Goodhart and Manoj Pradhan.

The co-authors of “The Great Demographic Reversal: Ageing Societies, Waning Inequality, and an Inflation Revival” predict that a long period of sluggish price increases is coming to an end. Huge global trends will lead to significant shifts in the supply of, and demand for, labour. Their persuasive case is timely. The pandemic has prompted governments to take on huge amounts of debt, once-unconventional policies have become the norm for central bankers, and investors are chasing assets buoyed by fiscal and monetary support. Resurgent inflation would have profound consequences for all of them.

For years, a plentiful supply of workers suppressed global prices. Goodhart and Pradhan estimate that the amount of labour available to the advanced economy trading system more than doubled between 1991 and 2018. The rise of China, the reintegration of central and eastern European economies into global commerce, broad demographic trends and rising female employment all contributed. That weakened labour’s bargaining power. As a result, income inequality worsened within advanced economies even though income gaps between countries narrowed. These are not new observations. But the whistle-stop tour of the economic literature on trade, demographics and labour markets, as well as a wealth of charts and data, provide solid foundations for the arguments that follow.

The duo believes that major demographic shifts, notably China’s shrinking working-age population and rising numbers of elderly people, mean the world economy is near an inflection point for inflation. The growing ranks of older people will consume rather than produce. That pushes up demand for goods and services relative to supply. This cohort will also need more carers – jobs, which the authors convincingly argue, robots cannot and should not perform.

Their discussion of trends in dependency, dementia and social care is one of the distinguishing features of “The Great Demographic Reversal”. When economists discuss big macroeconomic trends, they too rarely examine these topics in detail. The authors combine telling statistics, such as the estimated $1 trillion in direct and indirect costs of dementia, or a prediction that the number of people living with dementia will triple between 2015 and 2050 to 152 million, with anecdotal details that make their treatment of the subject anything but dry.

Goodhart and Pradhan tackle potential counterarguments to their thesis head on. For example, they dedicate a chapter to why Japan, which has endured persistent low inflation despite a rapidly ageing population, won’t be a template for the rest of the world. The country’s labour force was shrinking just as the global supply of cheaper, yet still efficient, labour was growing. Other economies can’t rely on the same conditions. The Japanese economy also has unique features, such as a labour market that benefitted insiders but hurt outsiders.

The analysis is interesting, both for its contribution to the overall argument and for its dissection of Japanese economic and corporate history. So is the book’s reasoning for why relatively large numbers of Indian and African workers may not be enough to compensate for China’s changing demographics. The authors are also admirably clear about important issues on which they are either agnostic or have less expertise, such as predicting the pace of innovation or the outlook for non-financial corporate investment.

This approach makes their conclusions more compelling. A long period of low interest rates allowed governments to rack up debt without pushing up the overall cost of servicing that borrowing, even before the pandemic. Companies also became more indebted, encouraged by the tax advantages of debt over equity financing. Goodhart and Pradhan predict that monetary policymakers, who in the past decade turned into the “best friends” of governments, companies, households with outstanding mortgages and the rich, will face a backlash if they try to combat the inflationary pressures that are in the pipeline. “The glory years of central bank independence may be coming to a sticky end,” they write.

If “The Great Demographic Reversal” has a flaw, it is that Covid-19 forced the authors to make a last-minute call on how the current economic crisis will affect their thesis. A postscript concludes that “an imperfect, inflationary future is coming to our doors faster than we had expected, thanks to the pandemic”. The two economists are right that huge fiscal stimulus is injecting cash directly into the economy in a way that central banks’ asset purchases did not. But they may have underestimated how much new waves of restrictions will weigh on activity, while overestimating how quickly the economic scars can heal. That does not, however, detract from the importance of a book that makes a cogent case for why trends that have persisted for several decades are set to reverse.

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