In-depth Analysis

Fashion and the Inflation Dilemma

 

Ever wondered why fashions come and go? How come skinny jeans, for example, will be trendy one season only to be frowned upon by the fashion police just a few months later? Trends are decided by elite designers, such as Giorgio Armani or Jean Paul Gaultier; creators of haute couture collections whose designs eventually drip down, from the exclusive catwalks of Paris and Milan, until reaching a department store near you. Fashion trends aren’t spontaneous phenomena, they vary according to the aesthetic parameters set by a restricted group of people.

As strange as it may sound, a similar dynamic occurs in economic policy making. A restricted group of very powerful individuals (i.e. the richest nations’ central bank and government officials, plus their advisers) decide what direction most countries will end up following in terms of monetary and fiscal policies.

Back in 2008, the world’s leading economies were forced to step in and save their financial systems from collapse, bailing out banks and other institutions with rescue packages worth trillions of US dollars, almost all of it drawn from gargantuan quantitative easing programs (that’s money printing, in case you’re wondering).

As debt-to-GDP ratios rose, a few powerful individuals, and their advisers, feared that the injection of such large amounts of capital in the economy would resurrect the 1970’s bogeyman: Inflation. Therefore, after the 2008 financial crisis, despite the absence of significant rising prices, that could justify its implementation, austerity became ‘fashionable’ and widely adopted across the world. According to many analysts, these austerity measures resulted in a decade of sluggish economic growth, with the real income of large segments of the population stagnating.

Fast forward to 2021. The planet’s leading monetary and fiscal authorities decided that, this season, austerity is out, while generous stimulus are in. The main central banks, from the Fed to the ECB, BoJ and BoE, all agree that the current loose monetary policies must be kept in place, despite obvious signs of rising consumer prices, as seen two weeks ago when the publication of the US inflation numbers for April showed a rise of 4.5%.

Meanwhile, governments are also happy to inject trillions of dollars’ worth of stimulus packages into the economy. To the combined effect of monetary and fiscal stimulus we can add the extra savings accumulated by those who, having maintained their income throughout the pandemic, were unable to spend as normal. All this results in a powerful cocktail that, as life starts returning to normal, is driving an explosion in demand and rising prices.

For the time being, the trend setters are dismissing the emerging inflationary pressures as a near-term phenomenon that will fizzle-out after the initial stages of the recovery, arguing that any controlling measures would, at this point, stifle the recovery. However, fashions change frequently, and today’s cool may be tomorrow’s naff. As the economic recovery gathers pace, will be interesting to see how committed the Federal Reserve and the other main central banks really are to their current stance.

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