Five Reasons Why We Are Inflation Bulls
In the spring of 2020, even when the world was clearly
entering the deepest recession in a generation, we argued that the recession would be sharper but
shorter. We forecast that the global economy would embark on a V-shaped recovery and that the recession
had unleashed forces that would alter inflation’s dynamics.
The consensus was and remains on
a different page. Last year, it underestimated the rebound in growth and overestimated the
disinflationary impact of COVID-19. This year, it is underestimating both growth and the upside to
inflation.
We differ with consensus on how the following five factors will shape the
inflation outlook.
First, private sector risk appetite has experienced limited scarring: As
we have argued at length, the pandemic was an exogenous shock. Policy-makers were unfettered by moral
hazard concerns and had little hesitation about underwriting household and corporate income losses to an
unprecedented degree. In particular, while unemployment cost US households US$330 billion in wage income,
they have already received US$1 trillion in aggregate in transfers, a figure that will rise as the second
round of fiscal stimulus kicks in. The excess saving of about US$1.4 trillion will provide the fuel for
pent-up demand to drive a sharp rebound in growth once economies fully reopen. We forecast GDP growth of
5.9%Y for the US in 2021, a full 2 percentage points above the consensus. With the Democrats taking
control of the Senate, hopes of further fiscal stimulus have risen (we expect an additional US$1 trillion
for COVID-19 aid in the near term and further healthcare/infrastructure spending initiatives later in
2021), along with prospects for an even stronger recovery.
Second, the loss from unemployment
overstates the economic loss: Like our growth expectations, our unemployment rate forecasts are more
bullish than the consensus. As things stand, about 78% of US job losses have come in COVID-19-sensitive
sectors, which will rebound rapidly once the economy fully reopens. Moreover, 68% of the job losses from
February-April 2020 are in low-income segments, and one should not overstate the impact on aggregate
growth, notwithstanding the need for additional policy support targeting low-income households.
Third, policy-makers are attempting to run the economy red-hot, with the aim of returning the economy
to its pre-COVID-19 unemployment rate. However, accelerated restructuring in the economy will mean that
displaced workers will need time for retraining. As this process unfolds, the labor market may tighten
even earlier than the headline unemployment rate implies. While this dynamic was also at play following
the 2008 recession, the recovery was more gradual, which crucially gave businesses and the labor market
ample time to adjust.
Fourth, policy-makers are pushing for further transfers to low-income
segments, and they are likely to continue reining in the trio of tech, trade and titans in an effort to
mitigate the impacts of a lower wage share and higher income inequality. The recession’s disproportionate
impact on lower-income households has exacerbated the pre-existing issue of inequality, increasing the
impetus for policy-makers to act. Further transfers, especially given how they are now in excess of lost
income, will impart an inflationary impulse. Disrupting the trio of tech, trade and titans, which have
played an important disinflationary role for the past 30 years, will dampen their disinflationary
impulse.
Finally, the Fed is committed to its 2%Y average inflation goal: The consensus
believes that it is one thing to target a 2%Y average inflation goal and another to actually get it. But
in previous cycles, the Fed had tightened monetary policy well before inflation moved above 2%Y
sustainably. This is unlikely to be the case this time, hence any initial rises in inflation will have
more time to take hold.
Morgan Stanley
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