FINANCIAL MARKETS FLASH

What to make of the current debate on whether inflationis back (or not)?

Inflation occupies a dark corner of savers’ collective unconscious, with several painful episodes in our recent memories as citizens and investors. Without going all the way back to 1920s Germany, the latest bout with inflation occurred in the late 1960s and early 1970s, driven by the double shock of a run-up in US federal debt to fund the war in Vietnam, followed by a spike in oil prices during the 1970s. These are indeed very painful memories for investors, and after hitting 1000 points in 1966, the Dow Jones did not surpass that mark again meaningfully until 1982, after radical economic and monetary measures had been taken, precisely to get out of the inflationary spiral!

With all that in mind, what are we to make of the current debates over the desired return of inflation? Central banks are enlivening this debate by maintaining massive monetary creation policies and 2% inflation targets in the US and the euro zone, targets that are having a hard time being met. In the euro zone, for example, inflation has not exceeded 2% since 2011. Meanwhile, given the massive debt that both governments (and companies) have piled up over the past several years, and which is being aggravated seriously by the Covid-19 crisis, higher inflation would help reduce debt/GDP ratios more rapidly by providing an extra boost to nominal GDP.

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