When this lockdown is over, I’m looking forward to buying a new TV and plants for my garden, as I had planned to a few weeks ago. And I am typical. The lockdown is creating enormous pent-up demand: when it ends, many of us will go on a spending spree buying the things we’ve so far been unable to.
Which poses the question: might this be inflationary?
This sounds a strange question. The slump in oil prices will help cut inflation generally. And unemployment is now soaring – something which should in theory help hold down prices and wages as well as demand.
Nevertheless, there are reasons to expect some inflation – and not just because sterling’s 6 per cent fall on its trade-weighted index since February will add to import prices.
One issue is that companies that are now suffering a lack of cash flow might use increased demand to raise prices to restore their balance sheets. Many companies that enjoy a modicum of market power – and they wouldn’t be profitable if they didn’t – have some choice between raising prices and profit margins or holding them down and going for growth. When cash is tight some will choose the former.
And they might have more power to do so. Insofar as companies go bust during this downturn, the survivors will benefit from having less competition. That’s good for us as shareholders, but not so good for customers.
A second problem is that we’ll see a mismatch between unemployment and vacancies. Bar staff and waiters who don’t get their jobs back will not immediately be able to get new jobs in those businesses enjoying increased sales – either because they lack the skills or because those business will in the first instance at least simply make their existing staff work harder than usual.
Such mismatches are common after deep recessions. This can be inflationary because the unemployed can’t compete for the new jobs. In the mid-1980s, for example, wage inflation was strong despite mass unemployment in part because unemployed industrial workers in the north and midlands did not bid down the wages of finance workers in the south. A similar thing happened after the 2008-09 recession. It led to unemployment co-existing alongside lots of vacancies, with the result that what looked like spare capacity did not hold down inflation: CPI inflation rose above 4 per cent in early 2011 even though the official unemployment rate was almost 8 per cent.
Recessions don’t just reduce 'aggregate' demand. They also disrupt the pattern of demand, which can itself be inflationary. Given its suddenness, this one might be no different.
This is not, however, a case against the loosening of monetary and fiscal policy. For one thing, recession and unemployment are certainties whereas higher inflation is only a possibility, and policy should give greater weight to certainties than to lower probabilities. And also, one of the most robust facts in the social sciences is that unemployment is a cause of huge unhappiness – more so than can be explained merely by the loss of income. Whereas 3-4 per cent inflation is an inconvenience, joblessness is a terrible misery. Policy should therefore put more weight upon the latter.
What it does mean, though, is that investors should not bet very much on nominal gilt yields staying low. If inflation does rise, they could rise with it.
