Market Overview

7 May 2020

After all, The Inflation Remains an Unlikely Scenario

Over the past few decades, the discussion about printing money and a clear increase in prices as a result has been unfavorable for the supporters of this theory - at least in developed countries. Basically, the argument focuses on the fact that if the supply of money increases faster than its actual production then ( ceteris paribus ), inflation will occur. That is, if a central bank prints money, then for starters families will have more money and they will perhaps then spend more on consumption. However, despite an increase in money in circulation - the quantity of goods does not change - thus an increase in prices is the outcome.

The reality is that since the great financial crisis of 2008, so much money has never been printed and yet inflation is slow to arrive. Irving Fisher's quantitative theory of money helps to understand why:

where M refers to the amount of money, V the velocity of money (the number of times that money changes hands), P and T in terms of price, and total amount of assets, respectively. What several economists point out is that as the money supply has expanded (M), the speed of money has decreased as well as the total quantity of goods increased - thus the equality of the equation is maintained by continuing product prices (P) relatively low .

Today, it is also possible to observe economists who point out scenarios of rising inflation as a consequence of the increase in the money supply, as well as others (say in large part) who say that prices will remain low. Those who indicate that there will be a price increase, say that the strong monetary and fiscal stimuli will be the main cause of this growth. Those who claim that inflation will remain low, mention the low prices of various raw materials, low expectations of inflation and a labor market where the demand for workers by companies is lower than supply (thus leading to a decrease in wages and therefore prices).

Olivier Blanchard says that there is a consensus among several economists that the probability of inflation as a result of these stimulus measures, is about three%. The former IMF chief economist points out, however, the steps of how this could happen:

- In the beginning, there would be a very large increase in budget deficits which, in turn, would lead to a rise in its public debts;

- Then, a possible decrease in risk aversion, as well as consumer savings, would lead to an increase in its natural rate of interest - interest rate on government bonds - indicated to bring the economy to its potential;

- Finally, in order to avoid an overheating of the economy, the central bank of the region would be forced to further increase its natural rate of interest, consequently leading to an increase in public debt and possibly the need for austerity measures.

However, none of this is happening and it is likely that only the first point will be realized .. Exactly the opposite is being observed - there is an aversion to risk and a strong increase in consumer savings, not only through measures of social restraint but also as a precaution in the face of an uncertain future.

Deflation is perhaps even more likely than a general and uncontrolled rise in prices. This situation is very undesirable, once it influences consumers' expectations it can be highly difficult to get out of. Inflation tends to promote consumption since prices are usually higher, however deflation retracts it, as prices will probably be lower in the future. A possible entry into this vicious cycle may not be the best scenario for an economic recovery.

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