Less Lower for Longer; More Higher and Sooner
Charles Goodhart | Episode 47
Charles Goodhart, CBE joined Markus’ Academy for a lecture on ‘Less lower for longer; more higher and sooner’. Goodhart is a Professor at the London School of Economics.
Watch the full talk below and download the slides here.
Highlights
Looking at the last three centuries, interest rates were steady up to 1950, after which they increased drastically up to 1980. This suggests that inflation expectations were steady before yields and expectations rose dramatically due to the Keynesian economics-driven policies.
From the 1980s to the present inflation rates and expectations went to historically low levels, due to globalization and demographic changes. Eastern Europe and China’s working age population (WAP) were included in the world’s trading organization, which doubled the worldwide labor force. Employers went from high skill to low skill production, and with relative prices held down, there were credible threats to producers for them to keep wages down. Shifts in demography after the WW2 baby boom led to a lull in the proportion of young in the economy. Now, the working age ratio is relatively steady, with the exception of Japan with a massive increase in retirees.
Shift of production from high wage to low wage has improved world equality but increased within-country inequality. World inequality increased from the 1800s to 1980, when America and Europe bounded ahead with the industrial revolution but Asia remained behind. Starting from 1980, Northern Asia has begun to catch up: the ratio of average wage in the US to China has decreased from 35:1 to 5:1. However, this led to increased competition for low wage workers in high wage economies, leading to more inequality within countries.
The increase in the number of elderly has led to sharp rises in expectations for deficits and debt, even before the pandemic. With the pandemic, this expectation has been exacerbated and increased.
Growth and government policies are unlikely to decrease deficits — the politically easier way to implement a solution will likely be inflation. Growth is an unlikely fix because the growth in the number of workers decline, so a dramatic increase in productivity would be required. The government is also unlikely to increase taxes and reduce expenditures due to political reasons. Therefore, the most politically likely result is inflation, which will be necessary to bring down the current deficit. Inflation will pick up a year after the pandemic has been alleviated with vaccinations and the economy opens up. The pandemic has led to huge monetary aggregates, leading the private sector to increase markups to pay back its debts. This will expedite the shift from low inflation to high.
Africa and India have a significant period of growth ahead of them, but their demographic upside is unlikely to become a comparable global tailwind to China because weaker policy coordination and implementation capacity limit how effectively population growth translates into scalable, exportable production. That also means “just send capital” is insufficient: institutional and administrative constraints reduce the productivity of capital inflows.
In summary, inflation will occur due to increased stimulus to households, the yield curve will steepen, asset returns will be harder to extract, within-country inequality will lower, and central bank independence will come under increasing threat.