28 May 2009
Inflation to ease the debt burden
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Please see importantdisclosures at the end of thedocument
What message are markets giving us?
Inflation expectations have changed radically.Between end-December 2008 and end-May 2009, US long-term inflation expectations literallytook off, chalking up the greatest surge ever seen over a comparable period. The yield on 10-year government bonds gained more than 100 bp, despite the implementation of the Fed
sbuyback plan. All told, the 10-30-year segment of the yield curve steepened by 100 basispoints.
No, inflation is not just around the corner.
Short term, world inflation will turn negative atleast for a few months, until the energy-price-related base effect falls out of the numbers.Thereafter, the anticipated pick-up in unemployment and persistently weak productioncapacity utilisation worldwide will stand in the way of a spontaneous uptick in inflation.
markets are looking beyond the next couple of months
. Indeed, we consider thatchanges in expectations could well reflect more structural factors: 1) exceptional economicpolicy responses to the current crisis provide fertile ground for an eventual return of inflation;2) by recovering the reins of financial and economic regulation, governments have giventhemselves powers relinquished long ago and considerably increased the weight of the non-competitive sector in the economy; 3) industrialised economies will be unable to get rid ofexcessive debt levels without help from inflation.
The probability of an inflationary exit to the current crisis has definitely increased.
Inflationappears to be the only way to address the issue of excessive debt. As a substitute forinsufficient growth in real wages, inflation can remove the debt burden while at the same timemaintaining viable economic conditions. Cruelly efficient, inflation of only 3% p.a. wouldautomatically send debt ratios down by one quarter over ten years, assuming growth in debtdoes not outstrip that of real GDP. With inflation at 4%, the stock of debt would be reducedby a third over an equivalent period.
Inflation: when, and what will the impact be?
After 20 years of global disinflation, the rangeof tools available to economists to predict the exact timing of a return of inflation have been jeopardised. Identifying the return of inflation
will thus require us to proceed in baby steps,attentively observing economic developments over the coming quarters:
H2 09, when the globaleconomy recovers, will be the test, as we should then obtain more hints as to the timing of areturn of inflation.
Far from representing a panacea, the inflation option is more of a necessary evil
in aneconomic context that has been pushed out of balance by the excessive borrowing of recentyears. Blocking such an option would force industrialised economies to accept a painfuldeleveraging process that would carry an unsustainable cost.
INFLATION – part oneThe basis of the debate
The aim of this document is topresent the groundwork for reflection on the currentinflation backdrop. A key topic for years to come,our discussion will becomplemented bycontributions from our variousresearch teams.