eco TV Week

Will the Covid-19 shock lead to a significant increase in the inflation rate ?

4/17/2020

There is no doubt that the Covid pandemic will lead to a short but deep world recession. However, the effect on inflation is unclear. If in the short term, many observers expect disinflationary bias, the medium-term inflation outlook is more ambiguous.

Louis BOISSET

TRANSCRIPT // Will the Covid-19 shock lead to a significant increase in the inflation rate ? : April 2020

There is no doubt that the Covid pandemic will lead to a short but deep world recession. However, the effect on inflation is unclear.

- In the short term, many observers expect disinflationary bias, due to: the drop in demand; the decline in non-food commodity prices ; open economies may have enough inventory to meet the demand.

- The medium-term inflation outlook is more ambiguous, one of the main questions is to know which one between the demand and supply shock is dominant. 2 scenarios are possible

 

  • Which dynamics can lead to significant higher inflation?

During a recession, the activity usually suffers from a lack of demand, but this is today a two-pronged shock. First, destruction of production capacity will weight on some sectors’ production. Then, when the health measures will get lifted, in response to the massive fiscal and monetary stimulus, inflation can surge given the remaining constraints on supply. Finally, the room for central banks to increase interest rates will remain very low given the high level of public debts.

More globally, the acceleration of the shortening process of global value chains may trigger an increase in production costs and a subsequent increase in inflation.

  • On the other side, what are the arguments in favor of disinflationary pressures?

From the supply side, this crisis will for sure lead to bankruptcies and a higher level of unemployed people. But, unlike wars or natural disasters, the current situation could not result in equivalent destruction of production capacity. Besides, during wars, governments acts as an employer of first resort, often resulting in higher inflation. This is unlikely to be the case today. Finally, we can expect some discounts in affected sectors, in the travel sector for instance.

From the demand side, Precautionary behaviors and a still high level of uncertainties could have a lasting negative effect on private demand, and thus on inflation dynamics.

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