Exaggerated Fears

We told you inflation was coming, but now it’s time to calm down

Customers shop at a Whole Foods store in New York
All this market crash stuff is giving me a headache. Source: Reuters

It’s an accurate stereotype that Germans worry constantly about the dangers of inflation, a by-product of the hyperinflation days of the Weimar Republic. For many foreigners, it’s become a little bit like the boy who cries wolf. So in recent years, when German economists predictably warned that overly loose monetary policies of central banks would lead to higher prices, an overheated economy and probably a market crash, it was easy to ignore.

Now, Americans are starting to think differently. News last Friday that hourly wages in the United States rose 2.9 percent in January served as a wake-up call for financial markets, which promptly crashed. Investors are suddenly worried that rising inflation will force central banks to raise interest rates faster than they thought. Scott Anderson, an economist from the Bank of the West, now warns that an already overheated US economy has just been given a stimulus injection from Donald Trump’s tax reforms.

This might be the time for Germany’s conservative scaremongers to cry “I told you so.” After all, Germans are famously risk-averse and have dabbled little in the rising stock market. That might give some of them a bit of Schadenfreude now that the market is slumping. But rather than doing victory laps, many German inflation hawks are now warning that the fears are exaggerated in the other direction. Their message is a plea for stability.

Take it from a German inflation hawk: Everybody needs to calm down.

The problem lies partly with expectations. Central bankers complain that they have always expected prices to rise again. That, of course, is their goal: The mandate of both the Federal Reserve and the European Central Bank is to keep annual inflation close to 2 percent. By contrast, the ECB’s vice president, Vitor Constancio, quipped back in November that nearly all investors seem convinced that inflation will stay low forever.

But most central bankers aren’t exactly innocent bystanders, either. Some had started to question whether fundamental economic theories still apply, such as whether there’s a link between falling unemployment and rising prices. With the US now near full employment, that link is reasserting itself: “The labor market is tight, so wages are rising again,” was the rather simple explanation from Deutsche Bank’s chief US economist, Torsten Slok.

A similar thing has been happening in the marketplace: Investors long recognized that US stocks were probably overvalued, but historically low interest rates meant they were still a reasonable investment – certainly better than safe bonds that earn you nothing. That thinking now seems to be over: The yield on 10-year Treasury bonds in the United States has noticeably risen to around 2.8 percent, making bonds a more attractive investment, and stocks seem comparatively more expensive than just one week earlier.

But just because there’s a sudden recognition that prices can rise again, doesn’t mean it’s right to fear that prices will now go through the roof. “The fears of rapidly rising inflation in the United States are unjustified,” said Adam Posen, a former British central banker who now heads the Peterson Institute for International Economics in Washington. Potential wage growth is still limited, he added, since many workers still don’t have a strong bargaining hand, while companies are loathe to raise prices and lose their competitive edge.

08 p35 Is inflation coming back-01

Wall Street’s crash has inevitably impacted the rest of the world, irritating investors and economists in Asia and Europe, where the dynamics described above have been far less exaggerated. “Unlike in the United States, the euro zone still has mass unemployment. Wage growth is not likely to accelerate,” said Jörg Krämer, chief economist of Commerzbank. That hasn’t stopped Germany’s DAX from taking a dive, too.

Jens Weidmann, president of the Bundesbank, on Thursday noted that while economic growth in the euro zone outpaced that of the United States last year, “inflation has not kept pace with economic expansion.” Core inflation, which takes out more volatile energy and food prices, is currently 1.2 percent in the euro zone, compared to 1.8 percent in the United States.

The one exception to that rule might be Germany, which is in the middle of a collective-bargaining season with unions that are demanding their members profit from the country’s booming economy. But even here, much of the focus is less on higher wages and more on concessions that improve work-life balance. IG Metall managed to eke out a slightly above-average 3.5 percent salary increase for metalworkers, but Holger Schmieding of Berenberg says he expects most of Germany’s exporters will stomach the higher labor costs themselves rather than pass them on to consumers.

Even Mr. Weidmann, himself a long-time critic of the easy money policies of central bankers, on Thursday said he still sees low inflation as a “rather widespread phenomenon” around the world. Loose monetary policies have driven up asset prices, but they haven’t yet had as big an impact on consumer prices. As a result, he says the ECB’s current monetary stance “remains appropriate,” though he doesn’t expect the central bank to loosen its policy any further.

“Nor should we allow ourselves to become unsettled by the decline in equity prices we have just witnessed. US equity prices rose over a prolonged period without any notable corrections, which was unusual given that valuations have been high overall,” said Mr. Weidmann.

In other words, take it from a German inflation hawk: Everybody needs to calm down.

Christopher Cermak is an editor with Handelsblatt Global in Berlin. Jan Mallien and Frank Wiebe cover monetary policy for Handelsblatt in Frankfurt. To contact the authors: cermak@handelsblatt.com, mallien@handelsblatt.com and wiebe@handelsblatt.com

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