The inflation scare is over: The pandemic was a perfect storm

I believe global central bankers are on the verge of making a mistake that will undermine growth.

The generals are always fighting the last war, and central bankers will continue to fight the specter of inflation, even as it becomes increasingly clear that the inflationary threat has passed and the greater danger is recession.

On Thursday, the European Central Bank’s chief economist Philip Lane noted that companies are telling them that wage pressures are easing. Their wage tracker also shows much slower wage growth in 2025 and 2026. There will be no secondary effects.

With the benefit of experience, it will soon become clear that the inflation that occurred during the past pandemic period was a one-time perfect storm caused by:

1. Very low prices, including irresponsible forward guidance.
2. uncontrolled financial spending
3. shock show

We put these three factors together, and all we got was a 9% inflation rate. All that was needed to suppress that inflation was an interest rate of 5%.

Does this look like a new normal of inflation, or just a blip in a long deflationary cycle?

To illustrate how crazy monetary policy is, here’s what the RBA did:

1. Reduce the cash interest rate to 0.10%,
2. $100 billion purchased via QE over six months
3. Pledge to buy $5 billion of government bonds weekly with commitment to continue through February 2022
4. Target yield on 3-year bonds of 0.10%
5. Directed not to raise prices until at least 2024

But they were certainly not alone. Central banks around the world were caught up in a monetary-policy easing frenzy – even going “full nuclear.” Ten-year US bond yields remained below 2% for two years and below 1% for most of that period. That was free money.

It was the same with governments. The Paycheck Protection Program scam in the United States resulted in $800 billion being distributed with little oversight. Much of that went directly into the pockets of small business owners. There was $850 billion in stimulus checks, followed by another $900 shot, and the cost of enhanced unemployment benefits was $680 billion. Compare that to the financial crisis, which authorized $700 billion in loans that had already had to be repaid.

Finally, a major source of inflation emerged through supply chains. All that money and low-interest lending went to consumers who decided to do things like renovate their homes and build fences and decks. Lumber prices soared to unprecedented levels.

Supply chains have been disrupted in autos, computer chips, consumer goods, meat, steel, and dozens of other places.

But the inflation rate is still only 9%.

I’m not saying it wasn’t painful and I think the delay in measuring things like housing meant that inflation was in the 12-15% range but it was a once in a lifetime event.

But somehow, central bankers are treating this as the beginning of a new normal. And what makes it even crazier is that we’ve seen the dawn of generative AI in the last 20 months. And that’s deflationary, of course, as I talked about yesterday with BNNBloomberg (near the end):

I wrote about that here too.

When the economic history of the pandemic is finally written, it will confirm that it was a one-off event in a long cycle of deflation, exacerbated by central banks keeping interest rates too high for too long.

I think this is a rare moment to lock in high interest rates for a long time in the same way that the pandemic was a once-in-a-lifetime opportunity to lock in low interest rates on borrowing.