USA: fear of inflation arises

To counteract the effects of the COVID-19 pandemic, the US Treasury and the Federal Reserve (FED) have deployed enormous monetary and fiscal policy efforts: On the one hand, the money supply has grown 27% between February 2020 and February 2021. On the other hand, the volume of US fiscal debt is expected to reach 130% of GDP by the end of 2021 as a result of increased spending. The impact of these actions – and of a successful vaccination plan – is significant: According to the FED, the US GDP will grow more than 6% in 2021, well above its long-term growth of 1.7%. As a result of this growth and the recovery experienced in the rest of the world, the CRB commodity price index increased by 36% since March 2020.

Accelerated growth and rising commodity prices have sparked fears of a resurgence of inflation. This fear, added to the elimination of the temporary exemption granted to banks from their obligation to immobilize capital to support their holdings of treasury bonds, triggered in recent weeks one of the most violent falls in this market in history. The ten-year bond has fallen 6% since December and the return required by its holders had to rise from 0.91% to 1.75% for demand from Asian and European buyers to pick up.

An inflationary phenomenon in the US would represent a change in trend given that, despite the monetary effort made since 2008, inflation remained below the Fed’s target of 2% in almost all the 7 years prior to 2020. Only in 2018, inflation reached levels of 2%.

Prices should temporarily rise in response to the acceleration, but before fearing a persistent inflation phenomenon, there are several factors to take into account:

(1) Increases in liquidity and public spending are inflationary if the economy is at full employment. The US economy today registers unemployment rates higher than its full employment rate (4.4%). If measured traditionally, unemployment is 6.2% and reaches 6.5% if those who have stopped looking for a job are taken into account because they have lost hope of finding one.

(2) The US economy today uses only 73.8% of its installed capacity. Neither the Fed nor the CBO (1) expect full use of this capacity to be reached before 2022.

(3) These measures constitute an attempt to fight against a deflationary process of several years that was aggravated by the advent of the pandemic. Like the US, in 2019 several developed economies such as Europe and Japan, among others, were going through a deflationary process that they have not been able to resolve. In their efforts, these countries have brought their government debt to GDP ratio to 98% in Europe and 255% in Japan in 2020. The amount of money grew in the twelve months to February 2021 by 22.0% in Europe and 13.4 % in Japan. After years of liquidity injections, the assets of the ECB (2) represented 99% of Europe’s GDP and those of the BOJ (3), 127% of Japan’s GDP. However, inflation of 1.3% is expected in Europe and 0.1% in Japan in 2021. Ten-year bonds issued by the German government today pay interest rates of -0.38%, those of Japan, rates of 0.07 %.

The rise in commodity prices should also be put into perspective: in April 2011 the CRB commodity price index peaked (14.4% above current levels) after rising 94.2% since 2008. In those three years, annual global inflation was 3.6%; in the US it was 1.5% a year, in the European Union it was 1.9% and in Japan, -0.8%. The Fed expects inflation in the US to rise from 1.4% in 2020 to 2.2% in 2021, before falling to 2%, its target level, in the following years.

(1) Congressional Budget Office.

( 2 ) European Central Bank.

(3) Bank of Japan.