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  • Abiye Alamina

Fueling Inflation?

This post will likely get a lot of flak from those who read it. But we must be realistic about the implication of certain policies, even in such dire times as we are now in.

The coronavirus pandemic has led to what most experts believe will certainly be an economic recession when all is said and done.

In the past several weeks, stock prices have fallen repeatedly, breaking historic records in the process and have shown to have no sustained upbeat reaction to various policy interventions, fiscal or monetary. It seems more like in reaction to a policy measure, the markets take a deeper plunge, and this has left many wondering, what gives?

I have alluded to this in previous blog posts that the coronavirus problem, though having demand side impacts, is fundamentally a supply side problem.

The first impact of the virus was on the huge global supply chain hub that is China, as factories shut down as workers and people in general were quarantined in a draconian fashion. With the arrival of the virus in the West and here in the United States in particular, while the initial response was tepid, subsequent actions have included similar widespread public and private sector closures, bans and social distancing policies, all of which are creating a spiraling decline in economic activity.

The implication of this is that much of domestic production has ground to a halt.

So with all of the demand side policy measures: lower interest rates, quantitative easing, fiscal stimulus with new rounds of the same proposing monetary payments to families, and various forms of income support for those who have lost their jobs as a result, for instance the weekly unemployment claims in Ohio shot up to 139,000 today compared to last week at 5,000, we have provisions being put in place to prop up spending.

But spending on what?

Inflation has a classic definition. It arises when you have too much money chasing too few goods. The problem here is that people are all at home, not at work producing stuff. Just in case you were carried away by the assumption that most productive work done in offices have moved to remote delivery, the surge in unemployment benefit claims tells the story. A whole lot of jobs cannot be carried out online or remotely.

So all that financial support will simply place money in the hands of households who will be empowered to bid for the fewer and fewer goods society is able to produce, and as inflation is a beast that feeds itself, people will find that the stimulus has not achieved much in terms of purchasing power, and they will clamor for more stimulus, and prices will only just keep rising, as politicians oblige.

This is because there is relatively little to no production taking place.

The only way to resume production is either to arrest the growth in the number of coronavirus cases, and this can only be done credibly by knowing the true number of those infected at any point in time, or to have a viable drug or vaccine for the disease. Since a viable vaccine is at least a year out according to scientists with expert knowledge of how long this takes, we can only hope for some temporary drug or perhaps seasonal change that helps to slow the virus down.

Only in any of the two scenarios can people return to work and production resume, but even then the pace cannot be ramped up immediately and may remain slow for several months in light of the expected workplace adjustments as businesses experiment with various levels of production in order to find out what the new normal would look like.

Is Stimulus then Bad Policy?

This is probably a catch-22 question. In an election year politicians of all stripes have to show that they are doing something to alleviate what affected individuals will see as a direct negative impact on them. The loss of a job on such short notice creates a lot of panic. Couple that with the loss by many of their investments as the stock markets have taken a serious beaten this month, and you have a lot of unhappy people.

What they want to hear is the good news of stimulus from the government. That the fat cats in D.C. with their secure jobs care for them or it is time to clean house. So politicians will act, as will their cohorts in other policymaking arenas, as the onus is also on them to mitigate a crisis.

So the Fed has acted and is still acting, in a manner similar to how it acted under Ben Bernanke during the Great Recession, but this is not the Great Recession. This is the coronavirus - a supply side problem - that includes a festering uncertainty about what can be done to address it.

The markets know and understand this, which is why policy measures have failed to cheer them up, and which is why though the general trend is down for the stock market, there are bursts of 100%+ price increases in biotech stocks the moment they show any signs of having covid-19 tests, or of beginning clinical trials on a vaccine, or of setting a date to begin such trials.

But governments around the world, even those not facing elections, are scrambling to put in place large stimulus packages. This has to have some merit, doesn't it?

Well, most economies have unemployment insurance that provides benefit payments for those who lose their jobs. This is intended to cushion the immediate impact of job losses by providing income support to facilitate household spending in the economy.

Providing additional fiscal stimulus might not be bad policy in the current climate to the extent that it helps to calm fears given the uncertainty about contracting the virus and the possible length at which unemployment situations will last. However this will only be a form of psychological comfort as prices will subsequently go up.

The stark reality is that while the coronavirus uncertainty remains, policymakers face a choice between allowing a chronic recession or inducing high inflation.

A political economy explanation for why policymakers around the world are providing stimulus packages other than the compelling need to do something and to take similar actions being carried out elsewhere, eludes me I admit. Perhaps inflation is believed to be the lesser of the two evils.

However, for the United States, one might surmise that in an election year, the gamble is on individuals suffering from money illusion: people are not entirely rational such that they think about purchasing power, their focus is instead on the stimulus provided. It is then easy to chalk up the inflationary pressures that will materialize to price gouging by opportunistic businesses. When the blame for an economic malady can be attributed to others by incumbent politicians, that is nirvana for them.


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