Plan Now
Tragically, the pandemic remains front and centre in the hourly, daily and monthly news. It’s a fast-changing reality: more infectious mutations of the virus have emerged, the roll-out of vaccinations remains sluggish at best, and lockdowns of entire economies have resumed or are imminent as hospitalizations and deaths continue to climb and overwhelm healthcare workers.
Thus, and rightly so, the world is focused on approving, manufacturing and distributing vaccines. There is little if any discussion, however, pertaining to what the long-term effects of these new vaccines might be, including the duration of their effectiveness. And similarly, the extraordinary fiscal and monetary measures, taken by policymakers in response to the pandemic, have been introduced then expanded with scant regard to how the resulting massive government deficits and bloated central bank balance sheets can eventually be unwound.
Fo example, look at central bank balance sheets, swollen by years of purchases of government debt, an exercise designed to lower long-term interest rates (so-called “quantitative easing” or QE). The issue here is not efficacy - long-rates were indeed lowered and have been kept so. The question is how and when this exceptional monetary easing should be relaxed then reversed post-pandemic.
The risk associated with QE lies with the prospect of a resurgence of inflation. Low inflation underpins virtually all economic policy and financial markets, explaining why central banks can cut short rates to near zero or even negative, and buy massive amounts of government debt. Rich world public-sector debt of 125% of GDP is barely spoken of, and the hunt for yield has sent stock market indices to record highs, despite a raging pandemic.
A majority of economists think the odds of a sustained era of inflation emerging after the pandemic are low (though a short burst is possible - even likely - with aggregate demand jumping as economies re-open). But since the policy consequences of even some acceleration in price increases above the common 2% target are serious, governments should act now to mitigate the risk. Issue long-term debt, not the currently cheaper short-term variety, and begin an orderly reversal of QE now, even if that means taking short rates negative. If the pandemic has proven anything, it is that not planning for rare events can be catastrophic. A resurgence of inflation, which would require painful policy adjustments, should be no exception.