As booming demand runs up against tight supply, inflation is in the spotlight. In April American consumer prices rose by 4.2% year on year, up from 2.6% in March. This partly reflects “base effects”: oil prices are only as high as they were in 2019, but 272% higher than in April 2020. It also reflects a genuine underlying rise in global prices. China’s factory-gate prices are rising at the fastest rate in over three years.
Central banks insist that their maximal stimulus must continue for fear of jeopardising the nascent recovery. Lael Brainard, a governor of the Federal Reserve, has said that the inflation spike as the economy reopens will be “largely transitory”. Jerome Powell, the chairman, sees little reason to worry. The Fed will tolerate somewhat above-target inflation for a bit, in part because it expects prices soon to fall back. So do many forecasters.
Yet this approach carries dangers. One is that inflation fades slowly. The supply bottlenecks of the early phase of the pandemic in 2020 cleared fast, but there is no guarantee this will happen now. Inflation expectations may also rise if people come to believe that central banks will act slowly and too late. Many companies are now discussing inflation with their investors. Bond-market traders think the Fed will be forced to act sooner than it wants. Bill Dudley, a former governor, worries that the Fed will have to raise interest rates to as high as 4.5% to cool the economy.
This points to the danger that sharp rate rises rock markets. So far the main event has been a sell-off in tech stocks, which is manageable. Banks are well capitalised. Yet the recent implosions of Archegos, a hedge fund, and Greensill Capital, a finance firm, are a reminder of the hidden leverage in a financial system that has come to depend on low interest rates. The post-pandemic boom may not always be exciting for the right reasons.