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Higher inflation is inevitable

Higher inflation is inevitable. Professor David Blanchflower Dartmouth, Stirling, NBER, IZA, The New Statesman and Bloomberg. 2. Financial collapse. The world economy was hit by a once in a 100 years financial shock – a Taleb black swan Geithner this week at Dartmouth said that

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Higher inflation is inevitable

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  1. Higher inflation is inevitable Professor David Blanchflower Dartmouth, Stirling, NBER, IZA,The New Statesman and Bloomberg 2

  2. Financial collapse • The world economy was hit by a once in a 100 • years financial shock – a Taleb black swan • Geithner this week at Dartmouth said that • ‘most of what feels bad about the American economy today is the aftershock of the crisis….we were on the edge of a catastrophic collapse....we looked into the abyss….we were at the cliff edge” • Bernanke worries about the death spiral • The scale of the shock has been under-estimated 3

  3. Alistair Darling

  4. Vince Cable: UK Secretary of State for Business, 25 May 2011 ”The thing that worries me more than anything else [is that] we really haven't engaged with the real depths and seriousness of the financial crash. I was very impressed with that Warren Buffett metaphor that asset-backed mortgage lending was the atomic bomb, and that there are hydrogen bombs out there. I just don't think that collectively governments have got to grips with this at all. So another huge bomb could go off, sooner rather than later? It's not imminent. But you can see this happening.” 6

  5. Where we are (1) • The central problem over the last decade was that • risk was under-priced, hence that price must rise. • This is a negative productivity shock • Most of the recent rise in inflation is ‘transitory’ • due to oil and commodity price increases and in the • UK a rise in VAT and a depreciation of the currency • The spreading sovereign debt crisis in Europe is a • major problem especially as the ECB is fighting • non-existent inflation. 7

  6. Annual inflation rates (%) – May 2011 Euro area 2.7 Netherlands 2.4 EU 27 3.2 Norway 1.6 Austria 3.7 Portugal 3.7 Belgium 3.1 Spain 3.4 Denmark 3.1 Sweden 1.7 Finland 3.4 UK 4.5 France 2.2 Germany 2.4 Greece 3.1 Ireland 1.2 Italy 3.0 Source: Eurostat, June 16th 2011 8

  7. Where we are (2) • The evidence from around the world is that growth • is slowing and the recovery will be protracted • This is no time to remove the fiscal stimulus • The US deficit needs to paid off within 10-15 years is the view of Geithner and Bernanke • Tax cuts look like a good idea especially to firms to stimulate investment and employment. • Greece has big structural problems and will default 9

  8. Ease of Doing Business, 2011 Singapore 100. Guyana Hong King 101. Guatemala New Zealand 102. Sri Lanka UK 103. Papua New Guinea USA 104. Ethiopia Denmark 105. Yemen Canada 106. Paraguay Norway 107. Bangladesh Ireland 108. Marshall islands Australia 109. Greece Source: United Nation’s Doing business Project www.doingbusiness.org/rankings 10

  9. Greece • Greece suffers from endemic tax evasion and a poor tax collection infrastructure • It has parochial patronage policies, corruption and big delays in courts dealing with tax disputes • It ranks 149th in ‘ease of starting a business’ and 153rd in ease of registering property • Providing more highly priced debt to an over-indebted country is ‘kicking the can down the road’ 11

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  11. The Exhibition Industry “Prior to last year, the largest single year decline ever recorded by the U. S. exhibition industry was 3.1%... and that was in 2008. The 12.5% decline recorded in 2009 and reported in this, the 2010 CEIR Exhibition Industry Index Report (CEIR Index), is four times greater than the downturn the industry experienced in 2008.” CEIR president Carrie Freeman Parsons Source: The Center for Exhibition Industry Research (www.ceir.org) 13

  12. Exhibition Industry Decline Tracks GDP Fall But is Bigger Source: The Center for Exhibition Industry Research (www.ceir.org) – ‘The CEIR Index Report. An analysis of the 2009 Exhibition Industry and Future Outlook’ 14

  13. Exhibition Industry Decline Source: The Center for Exhibition Industry Research (www.ceir.org) – ‘The CEIR Index Report. An analysis of the 2009 Exhibition Industry and Future Outlook’ 15

  14. Real GDP by industry and % changes in value added 2008 2009 Gross Domestic Product 0.0 –2.6 Total private industries –0.7 –3.0 Construction –5.7 –15.6 Total Manufacturing –4.8 –8.6 Durable goods 1.0 –12.7 Transportation and warehousing 0.8 –13.0 Arts, entertainment, recreation, accommodation, & food services–4.6 –8.7 Government 2.1 0.8 Private goods producing industries –4.2 –6.4 Private services producing industries 0.4 –2.1 16 Source: Economic report of the President, February 2011, Table B13

  15. QE and slowing growth prospects • The likelihood of QE in the US has risen. Rates • will remain low for an ‘extended period’ • The point of ‘competitive’ QE is to 1) raise asset • prices and 2) depreciate the currency. • The latest MPC minutes show that QE is back • on the table in the UK and private sector asset • purchases likely but not possible in the USA . • The UK market yield curve predicts interest • rates won’t rise until mid 2012 17

  16. Source: Financial Times, June 26th 2011

  17. FOMC reduced growth forecasts 2011 2012 2013 Change in GDP 2.7-2.9 3.3-3.7 3.5-4.2 April projection 3.1-3.3 3.5-4.2 3.5-4.3 Unemployment rate 8.6-8.9 7.8-8.2 7.0-7.5 April projection 8.4-8.7 7.6-7.9 6.8-7.2 Inflation 2.3-2.5 1.5-2.0 1.5-2.0 April projection 2.1-2.8 1.2-2.0 1.4-2.0 Core Inflation 1.5-1.8 1.4-2.0 1.4-2.0 April projection 1.3-1.6 1.3-1.8 1.4-2.0 Source: Federal Reserve Board of Governors, June 21-22 FOMC meeting – economic projections 19

  18. Oil price • Oil price has fallen to approximately $90 a barrel • Driven by US releasing 30m barrels from strategic reserve. The UK, Japan, Germany, France, Spain • and Italy also contributed. • Done to prevent short term supply disruptions, particularly from Libya, that 'could damage the economy and threaten the global economic recovery' • The fall in the oil price will push down on inflation and help growth. Deflation worries persist. 20

  19. Inflation vs Deflation • If there is hyper-inflation we know what to do • Inflating the debt away looks attractive especially where there have been large declines in house prices such as the USA, Ireland, Spain and the UK. • At some point interest rates need to rise to normal levels so when the next shock arrives they can be cut • Moves by the ECB to raise rates as in July 2008 even though Euro Area was already in recession – • and quickly reversed – is likely a major policy error. 21

  20. Wage Inflation • After the oil price hikes of the 1970s unions were able to obtain very large wage increases not least because of the rapid increase in unionization rates • Union density has fallen sharply. Globalization has weakened workers’ bargaining power. Wage growth • is benign around the world. There is no evidence of second-round effects. • Central banks should react to an oil shock when wages don’t rise by loosening monetary policy. 22

  21. Annual % change in hourly labor costs – Q12011 Euro area 2.6 Netherlands 2.6 EU 27 2.7 Norway 4.4 Austria 3.0 Portugal 0.8 Belgium 3.5 Spain 1.9 Denmark 3.2 Sweden 1.6 Finland 2.3 UK 2.1 France 3.8 Germany 2.9 Greece -6.8 Ireland -2.2 Italy 2.8 Source: Eurostat, June 20th 2011 23

  22. Difficulty paying bills ‘most of the time’ March 2011 May 2010 Belgium 7 6 Denmark 3 2 France 14 8 Germany 5 5 Greece 35 22 Ireland 18 8 Italy 13 8 Netherlands 3 4 Portugal 19 12 Spain 14 9 Sweden 2 1 UK 10 6 24

  23. Financial crisis a major failure of macroeconomics • “The state of macro is good” (IMF Chief economist Olivier Blanchard, ‘The state of macro’, NBER WP14259, August 2008) • “Over the last three decades, macroeconomic theory and the practice of macroeconomics by economists have changed — for the better. Macroeconomics is now firmly grounded in the principles of economic theory” (V. V. Chari and P. Kehoe (2006), ‘Modern macroeconomics in practice: how theory is shaping policy’, Journal of Economic Perspectives, Fall, pp. 3–28) 25

  24. NobelLaureateRobertSolow (2008) “The other possible defence of modern macro is that, however special it may seem, it is justified empirically. This too strikes me as a delusion. In fact ‘modern macro’ has been notable for paying very little rigorous attention to data. …I am left with the feeling that there is nothing in the empirical performance of these models that could come close to overcoming a modest scepticism. And more certainly, there is nothing to justify reliance on them for serious policy analysis” Robert Solow (2008), Journal of Economic Perspectives, 22(1), Winter, pp. 243-249. 26

  25. August 2008. GDP projection based on market interest rate expectations – includes no financial sector 27

  26. May 2011 GDP projection based on market interest rate expectations and £200 billion asset purchases – still includes no financial sector

  27. May 2011CPI inflation projection based on market interest rate expectations and £200 billion asset purchases

  28. The Great Recession • Growth comes from ‘bank lend or government spend’. • There is no believable evidence that fiscal retrenchment in a recession works e.g. Canada. • Austerity failed in Portugal, Ireland, Greece and the UK • Animal spirits are a major problem in many countries • The recovery looks to be highly interest rate sensitive • Consumer confidence and retail sales in the UK have collapsed and growth has been revised down not up. 30

  29. Conclusion • There does remain a major risk of deflation, especially • if growth disappoints. There is little evidence of second-round effects and inflation expectations remain anchored. • Deflation would be much worse than inflation. • Expansionary fiscal contractions are ‘oxymoronic’ and • are not working. U-turns are coming. • Interest rates will remain low for a long time • Monetary policy will remain loose for several years and • I certainly don’t rule out more QE. 32

  30. End Thank you 33

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