You won’t like what comes after inflation
The post-inflation new normal could look a lot like the low-growth hole the US was in for years
After we curb inflation, then what?
We have lost sight of this question over the last year or so, caught up in the drama of a price spiral unprecedented in most of our lifetimes. But whether the Fed has crashed the economy into a recession or still manages to engineer the soft landing, we are likely to emerge from this episode into a difficult economic landscape that presents problems with no straightforward solutions.
It does appear we are on the way out. Investors in bond markets are expecting inflation to moderate in a couple of years. Despite hiccups in China, global supply chains seem to be recovering from the pandemic shock. The Fed is raising rates pretty furiously and the last vestiges of the enormous rounds of fiscal stimulus to demand are waning, trimming personal savings. Job growth is slowing.
The problem is that the new normal will return us to a version of the hole we've been in: a morass of shrinking workforces and low investment, stagnant wages and rampant inequality that gummed up prosperity for years.
The critical economic question – where does growth come from?– will get even trickier if energy remains expensive and China stops growing like an emerging market and starts slowing like a developed one.
Unlike bouts of inflation – a problem that the Federal Reserve and other central banks have learned how to deal with by raising the policy interest rate – the post-inflation scenario is hard to diagnose, let alone solve.
Aging is shrinking the size of the labor force, raising dependency rates not only across rich nations but also in China.
This dynamic lies at the heart of many of our misfortunes, stunting economic growth. It is a core driver of so-called "secular stagnation," which before Covid-19 was considered the main economic challenge of our times: a combination of high savings and lackluster investment that has given us stubbornly low growth alongside stubbornly low inflation and stubbornly low real interest rates.
Stagnation seems likely to stay with us. Olivier Blanchard, former chief economist at the International Monetary Fund (IMF), notes how workers expecting to spend longer shares of their longer lives in retirement will spend less and save more. Lower fertility rates push in the same direction, reducing the future workforce relative to the pool of retirees.
It would be tough to solve this puzzle even if everybody agreed on its features. Try as it did to goose the economy by buying up long-term debt, the Fed undershot its inflation targets for years. Growth disappointed for a decade following the financial crisis and interest rates remained at rock bottom.
Some economists suggested lots more government spending might help to bolster demand. But that argument is unlikely to carry the day, after the big fiscal stimulus packages of 2020 and 2021 contributed to an uncontrolled burst of inflation not seen in four decades.
There is, moreover, nothing near consensus on the diagnosis. Other related factors are also at play: Income inequality has likely depressed spending and increased savings; so has corporate concentration. A heightened risk perception – due to everything from pandemics, geopolitical upheavals and lengthening supply chains to maybe regulatory uncertainty – has also probably weighed on investment. And de-globalisation, if it indeed persists, will likely further push prices up and economic growth down.
People can't even agree about how aging will play into the future. Some economists at the IMF argue that just as the demographic bubble produced by the boomer generation kept inflation relatively low for 40 years as they worked and saved for retirement, it will push inflation up as they leave the workforce and spend down their nest eggs.
Charles Goodhart of the London School of Economics points roughly in this direction. The period of low inflation since roughly 1980 was a historical outlier, he says, mainly produced by increasing the pool of labor, not least due to the incorporation of China's vast labor force into world markets. This demographic dynamic is now being reversed – bringing about low growth and higher prices.
What do policymakers do with all this? A wildcard that could soften the blow is raising the retirement age. But the politics of that are not easy. (See "Macron, Emmanuel.") Faster productivity growth would help. Somewhat surprisingly, Daron Acemoglu and Pascual Restrepo of MIT have found that societies that were aging faster experienced higher growth, perhaps due to more investment in automation.
As measured, though, productivity growth has been far from spectacular.The uptick experienced during the pandemic seems unlikely to stick, says John Fernald of the Federal Reserve Bank of San Francisco. However exciting innovations like CRISPR and Tesla may look, technological progress seems somewhat stuck, compared to the more distant past.
Raghuram Rajan of the University of Chicago, former head of the Reserve Bank of India, suggests a change in perspective. If monetary policy failed to reinvigorate growth and fiscal stimulus gave us bursting inflation, perhaps the solution is more Build Back Better and less American Rescue Plan: government spending not to juice demand but to build the physical and social infrastructure that can pull left-behind America out of the doldrums and put it nearer the productivity frontier.
That might even help the nation's politics. While this opportunity may have receded for now, it may not be lost for good. "Maybe when we're back to low inflation," he said. That may not be too far away.
Eduardo Porter is a Bloomberg Opinion columnist covering Latin America, US economic policy and immigration. He is the author of "American Poison: How Racial Hostility Destroyed Our Promise" and "The Price of Everything: Finding Method in the Madness of What Things Cost."
Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement
