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Feb. 23, 2021, 10:42 a.m. EST

Inflation could make a stealthy comeback, with devastating consequences

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By Axel A. Weber

ZURICH, Switzerland ( Project Syndicate )—Current forecasts by many banks, central banks, and other institutions suggest that inflation will not be a problem in the foreseeable future. The International Monetary Fund, for example, expects global inflation to remain  subdued  until the end of its forecast horizon in 2025.

But could those who heed these forecasts be in for a rude awakening?

Economic models have long been notoriously inaccurate in predicting inflation, and COVID-19 has further complicated the challenge. While economic forecasters calibrate their models using data from the last 50 years to explain and predict economic trends, today’s economic conditions have no precedent in that period. Today’s low inflation forecasts are thus no guarantee that inflation will actually remain low.

MarketWatch explainer: Inflation worries are back. Here’s what you should worry about – and what you shouldn’t

Pandemic may not be deflationary

Even without additional inflationary pressure, reported inflation rates will rise significantly in the first five months of 2021. By May, UBS expects year-over-year inflation to rise  above 3%  in the United States and  toward 2%  in the eurozone, largely owing to the low base in the first half of 2020, when pandemic-related lockdowns began. The higher rate therefore does not point to rising inflationary pressure, though an increase above those levels would be a warning sign.

Many argue that the COVID-19 crisis is deflationary, because pandemic-mitigation measures have affected aggregate demand more adversely than aggregate supply. In the first months of the crisis, this was largely the case: in April 2020, for example, oil prices fell toward, or even below, zero.

But a detailed look at supply and demand reveals a more nuanced picture. In particular, the pandemic has shifted demand from services to goods, some of which have become more expensive, owing to production and transport bottlenecks.

In current consumer-price calculations, rising goods prices are partly offset by falling prices for services such as air travel. But in reality, pandemic-related restrictions mean that consumption of many services has fallen sharply; significantly fewer people are flying, for example. Many people’s actual consumption baskets have thus become more expensive than the basket that statistical authorities use to calculate inflation.

Breaking news: Wholesale inflation posts biggest surge since 2009, PPI shows, but it’s unlikely to be sustained

So, true inflation rates are currently often higher than the official figures, as  reports  have confirmed.

Once governments lift mobility restrictions, services inflation also may increase if reduced capacity—as a result of permanent closures of restaurants and hotels, for example, or airline layoffs—are insufficient to meet demand.

Even greater risk

The unprecedented fiscal and monetary expansion in response to COVID-19 may pose an even greater inflation risk. According to UBS estimates, aggregate government deficits amounted to  11% of global gross domestic product  in 2020, more than three times the average of the previous 10 years. Central banks’ balance sheets increased even more last year, by 13% of global GDP.

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