Deutsche Bank warns of a global “time bomb” due to rising inflation

Inflation may look like a problem that will go away, but it is more likely to persist and lead to a crisis in the years to come, according to a warning from Deutsche Bank economists.

In a forecast far beyond the consensus of policymakers and Wall Street, the German warned strongly that focusing on incentives while rejecting inflation fears will prove to be a mistake, if not in the short term, then in 2023 and above out.

The analysis points in particular to the Federal Reserve and its new framework in which it will tolerate higher inflation in the interests of a full and inclusive recovery. The company claims the Fed’s intention not to tighten monetary policy until inflation shows a sustained spike will be devastating.

“The consequence of a delay will be a greater disruption to economic and financial activities than it would otherwise if the Fed finally acted,” wrote Germany’s chief economist David Folkerts-Landau and others. “This, in turn, could lead to a major recession and create a chain of financial emergencies around the world, particularly in emerging markets.”

As part of its inflationary approach, the Fed will not raise interest rates or cut its asset purchase program until it sees “significant further progress” towards its inclusive goals. Several central bank officials have said they are not close to these goals.

Meanwhile, indicators such as consumer prices and the price indices for consumer spending are well above the Fed’s inflation target of 2%. Policy makers say the current surge in inflation is temporary and will ease once the supply disruptions and base effects from the first few months of the coronavirus pandemic wear off.

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The German team disagrees, saying that aggressive incentives and fundamental economic changes will have inflation ahead of them, for which the Fed will be ill-prepared.

“It may be a year longer until 2023, but inflation will come back. And although it is admirable that this is so
The patience is due to the Fed’s shift in priorities to social goals, the neglect of inflation is leaving the world economy on a time bomb, “said Folkerts-Landau.” The effects could be devastating, especially for the most vulnerable in society. “

Most of the streets are seeing tame inflation

However, the position of the Germans is not generally represented by economists.

Most on Wall Street agree with the Fed’s view that current inflationary pressures are temporary and doubt that policy changes will happen anytime soon.

Jan Hatzius, chief economist at Goldman Sachs, said there were “strong reasons” to support the position. One he cites is the likelihood that the phasing out of expanded unemployment benefits will put workers back in their jobs and ease wage pressures in the coming months.

On price pressures in general, Hatzius said much of the current surge is being driven by “the unprecedented role of outliers” which will ebb and bring levels back closer to normal.

“All of this suggests that Fed officials can stick to their plan of gradually stepping out of the loose current political stance,” wrote Hatzius.

From the Germans’ point of view, this will be a mistake.

Congress has approved more than $ 5 trillion in pandemic-induced incentives to date, and the Fed has nearly doubled its balance sheet to just under $ 8 trillion through monthly asset purchases. The stimulus continues, even with an economy projected to grow by about 10% in the second quarter and an employment picture that averaged 478,000 jobs per month in 2021.

“Never before have we seen such a coordinated expansionary fiscal and monetary policy. This will continue when production goes beyond potential, ”said Folkers-Landau. “That’s why this time is different for inflation.”

The German team said the inflation ahead could resemble the experience of the 1970s, a decade when inflation averaged nearly 7% and was well into double digits at various times. Rising food and energy prices, as well as the end of price controls, helped fuel the rising inflation of this era.

At the time, then Fed chairman Paul Volcker led efforts to contain inflation, but had to implement dramatic rate hikes that sparked a recession. The German team fears that such a scenario could play out again.

“Many sources of rising prices are already penetrating the US economy. Even if they are temporary on paper, they can affect expectations just as they did in the 1970s,” they said. “So the risk is that even if they are only embedded for a few months, they can be difficult to contain, especially at such high levels of stimulus.”

The company said rate hikes could “wreak havoc in a debt-heavy world,” with financial crises particularly likely in emerging markets, where growth cannot overcome higher borrowing costs.

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