Inflation and the cost of the Covid stimulus


After 30 years of low inflation, could this benign era come to an abrupt end given unprecedented Covid-19 global fiscal support policies? This article highlights longer-term trends and central bank responses


W


hile the hyperinflation seen in Venezuela (2019), Zimbabwe (2007) and Germany in the 1920s does not look set to reappear in G20 economies anytime soon, such examples are stark warnings of what happens in extremis. Price rises of more than 10% a year can destabilise economies and deter foreign investment. Deflation, triggered when prices fall, creates another set of problems – a rise in the household debt burden where consumers have borrowed in the past and reduced their spending.1


What the ‘new normal’ will look


like as economies emerge from Covid-19 shock looks set to vary from region to region, with various factors at play including demographics, labour supply, and demand.2


Cost of recovery


On 31 March 2021, US President Joe Biden unveiled details of his administration’s keenly


6


anticipated American Jobs Plan, a US$2.25trn infrastructure investment programme. It followed the US$1.9trn fiscal stimulus to reboot the US economy after the pandemic’s impact on growth and jobs.


While the fiscal stimuli from other major economies in response to the crisis are less eye-watering, Germany’s third supplementary budget within a year (March 2021) injected a further €60bn into Covid-19 relief measures, raising the country’s net federal borrowing to €240bn, an all-time high that is equivalent to 6.8% of GDP.3


Germany’s federal government


is now targeting a 2022 deficit of €81.5bn (2.2% of forecast GDP). This is a number that is “clearly incompatible with the normal debt brake rule” (that limits new borrowing to 0.35% of GDP), but the intention is to cut it sharply to €10bn in 2023, 2024 and 2025. Equally stark forecasted figures for the


UK have improved slightly.4 Analysts


believe its 2020−2021 borrowing figure, forecast initially by the Office for Budget Responsibility (OBR) at nearly £330bn (€380bn), could now undershoot by at least £20bn (1% of GDP) – and more if, as expected, GDP for 2021 comfortably exceeds the OBR’s 4% forecast.


However, with the cost of reviving global economic growth – from furlough schemes to loans and tax credits for keeping businesses afloat – now spoken of in trillions rather than billions, figures such as former US Treasury Secretary Larry Summers have expressed alarm. They caution that measures such as the Biden package are evidence that central banks and finance ministries are overly reliant on tax and spend policies that could lead to economies overheating.


Images: Alamy


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