PCR podcast: A very expensive post-pandemic recovery

The pandemic has triggered an economic crisis such as the world has never seen. The economic downturn was followed by an unprecedented rebound. It all happened so fast. It left us with a torrent of numbers and seemingly inextricable questions.

Welcome to PCR, a special limited series by The National in which we try to make sense of the numbers and answer important questions on the Post Covid-19 Recovery.

Listen to prominent economists and business leaders as they explain the challenges and opportunities of a unique and often complex economic recovery.

Join Mustafa Alrawi, assistant editor-in-chief as he explores the many features of the Post Covid-19 Recovery.

Episode 4 : A very expensive recovery

The Post Covid-19 Recovery continues to progress whilst inflation is reaching historic levels and consumers are being squeezed by higher prices. The annual rate of inflation in the United States hit 6.2 per cent in October 2021, the highest in more than three decades. On the other side of the Atlantic, inflation has pushed the cost of living in the UK in October to a 10-year high.

Global food prices have hit the highest level in over a decade after rising by more than 30 per cent in the last year, according to the United Nations Food and Agriculture Organisation (FAO).

But what does that mean for the economy?

What does higher inflation tell us about the state of the recovery and, most importantly, why is a persisting high inflation a real threat to the recovery ?

Find out more about what is causing these historic inflation rates and when economists think the situation will start improving.

Guests:

Laurence Boone, Chief Economist at the Organisation for Economic Co-operation and Development, OECD

Petya Koeva Brooks, Deputy Director in the IMF's Strategy, Policy, and Review Department

Mahir Rasheed, US economist at Oxford Economics

Simon MacAdam, Senior Global Economist at Capital Economics

Ezra Greenberg, Partner, Strategy and Corporate Finance Practice at McKinsey and Company

Martin Hirt, Senior Partner at McKinsey and Company

Narrated by: Mustafa Alrawi, The National's assistant editor-in-chief

Episode transcript:

Mustafa 00:12

Prices are higher, goods are more expensive. Everywhere around the world, consumers are feeling the bite of an expensive recovery. The post-Covid-19 recovery continues to progress, while inflation is reaching historic levels and consumers are squeezed by higher prices. In fact, inflation isn't just progressing. It's accelerating. The rate of inflation in the US in October was double the rate of September. And there's a consensus inflation will peak at some point during 2022. While there aren't any red flashing lights just yet, economists, investors and central bankers are starting to worry that the current uptick in inflation rates could last longer than previously thought. But what does that mean for the economy? What does higher inflation tell us about the state of the recovery? And most importantly, why is persistently high inflation a real threat to the recovery?

01:27

We're talking so much about inflation and the effects that it's having on the consumer.

01:31

What does it mean for America if we get a sustained higher oil price? And no, this is not just about gas prices. Prices are surging more than they have in 30 years and there doesn't seem to be an end in sight.

01:44

You hear Powell coming out and using that word uncertainty. We know the markets don't like that word.

01:50

This is a historic inflation report and is landing just before the holidays.

01:55

The question now is, is Powell trying to get ahead of inflation too late?

01:59

Core prices were up by the most since August of 1991.

Mustafa 02:06

Welcome to PCR, the special podcast series from The National. I’m Mustafa Alrawi, your host in this limited series, in which we are exploring some of the features of the post-Covid-19 recovery, PCR.

Whenever there's an economic rebound, there's inflation. In a sense, inflation is the shadow, some would say the echo of a bright economic recovery. The bigger the rebound, the greater the inflation rate. So no one should be surprised to see higher prices following an unprecedented downturn, such as the one the world witnessed in 2020. What worries economists and consumers is what happens next. How far could prices increase before stabilising? How long could it take before prices start going down? And what happens if the imbalances causing the high inflation persist?

Ayesha 03:10

Simon MacAdam, Senior Global Economist, Capital Economics

03:15

So you're going up from rates of below 2 per cent global inflation up to what we are now at, which is about 4 per cent, as of July-August. And the fact is that a lot of the effects that have pushed up inflation are temporary. Some of them are even arithmetic effects that mechanically boost inflation rates, because inflation is a year on year concept. So any growth rate partly tells you information about what's happening now, but it also partly reflects what happened a year ago. Of course, a year ago, some very odd things were happening in the economy, including lockdowns that were distorting prices, which should start to drop out in the coming months. And one of those factors also is the effect of commodity prices in boosting inflation rates. And this should also drop down next year as well and drag down on inflation rates globally. So these sort of 4 per cent rates that we're at now shouldn't last. And that's sort of a consensus view, that there's a difference of opinion amongst economists about how far inflation will fall next year, but as a general view, that it will fall. Now the question is, how fast will it fall? How far will it fall? And that's where the uncertainty and the debate lies.

Mustafa 04:39

There are many ways to measure the rate of inflation using different metrics and definitions. The consumer price index is one of those measurements that effectively tell us how prices are going up or down, and how this is affecting our purchasing power, and ultimately, the real value of our money. The annual rate of inflation in the US hit 6.2 per cent in October 2021, the highest in more than three decades, as measured by the consumer price index. In fact, prices for most goods have gone up almost everywhere, though not to the same extent as in the United States. In a way inflation reflects the pressure and the various imbalances of the recovery. Trade disruptions, higher shipping costs, labour shortages, higher commodity prices, higher energy prices, higher demand on specific products, slower production, it all adds up to boosting inflation rates and pushing prices upwards. So far, economists tell us that these imbalances are a side-effect of a strong economic rebound, and that these disruptions should ease gradually.

Ayesha 05:55

Petya Koeva Brooks, Deputy Director in the IMF's Strategy, Policy, and Review Department

06:00

Our baseline view on inflation is that, while we are seeing elevated levels at the moment, the factors behind it are mostly transitory and they will play out. And inflation will come down to more normal levels towards the middle of next year for the advanced economies as a group. Now, it's also important to keep in mind that there are quite a lot of differences across countries. So again, I don't want to lump everybody together here.

Ayesha 06:45

Mahir Rasheed, US economist at Oxford Economics

06:49

A key driver of inflation in the US is inflation expectations coming from consumers, businesses. It’s somewhat of a self-fulfilling prophecy that, if you expect higher inflation in the future, then you will be changing your behaviour today. So, as I mentioned, consumer sentiment. One of the really important measures that we get from that release are inflation expectations from consumers. And we've seen that near-term inflation expectations over the next year have become extremely elevated recently. I believe in the September release, they were hovering at about 4.7 per cent. However, longer term inflation expectations over the next five to 10 years still remain anchored around 3 per cent. Now, there's certainly a risk that the rise in debt could fuel this inflationary psychology that could snowball into households putting off purchases and workers demanding larger wage increases to offset higher inflation, creating a so called wage-price spiral that the economy saw in the 1970s. However, we don't necessarily expect this to be the case. One of the main reasons is because, as I mentioned, longer term inflation expectations still remain in a very comfortable range, especially after the past decade where inflation measures have actually consistently undershot the Feds to present target. The August CPI figures that we recently got also showed a moderate increase in headline and core inflation. But importantly the reopening sectors – that includes airlines, used cars, accommodation – that played a significant role in this year's current surge inflation, actually posted widespread declines for the first time in five months.

Mustafa 08:37

You've heard it from Petya Koeva Brooks of the IMF, and Mahir Rasheed, senior economist at Oxford Economics. The factors behind current high inflation are mostly transitory. Supply bottlenecks and shortages in semiconductors, in addition to higher oil prices are also likely transitory. But the fact is that higher prices are real and already a drag on consumers’ purchasing power. In the US, PC prices rose by 8 per cent on a yearly basis, TVs by more than 10 per cent, washer-dryers up by nearly 15 per cent. On the other side of the Atlantic, inflation has pushed the cost of living in the UK to a 10-year high in October. The surge may be transitory, but this figure is now more than double the target set by the Bank of England. The inflationary trend goes well beyond electronics, cars and other manufactured products. High inflation is also affecting many products of first necessity. Labour shortages, border restrictions and higher energy prices are causing a spike in food prices. This is having a major impact on low-income economies, where households spend a larger share of their income on food and basic items. Global food prices have hit the highest level in over a decade after rising more than 30 per cent in the last year, according to the UN's Food and Agriculture Organisation. The agency's figures highlight the soaring cost of cereals and vegetable oils around the world. Covid-related factors are partly responsible for the increase in food prices. Other reasons include climate-related events, adding price tensions to the landscape of the post-Covid-19 recovery.

Ayesha 10:37

Laurence Boone, Chief Economist at the Organisation for Economic Co-operation and Development, OECD

10:44

When we look at inflation, there are many factors behind the higher and more persistent inflation projections that we have. That's energy, this has to do with tensions on the supply chain and at various stages of the supply chain. It also has to do, in some instances, with labour shortages, and also private demand consumption, having been very strong for a long time. Now, when it comes to the supply tensions, we think those will gradually fade away, as the health and economic situation normalises. As you know, we have those tensions because of sanitary processes, some borders being closed and some production plants not functioning normally. So all of these have to do with the disruption from the crisis. When it comes to demand, or excess, or the rebound of demand, some of it has to do with the reopening of the economy and should fade away. Sometimes some of this has to do with very strong fiscal support, which should be gradually withdrawn. So overall, looking into the future, the demand and supply factors that I have been describing, we think will normalise. Food, traditionally, is volatile because of the weather. But one factor that we think should also improve is the fact that food and agriculture employs a lot of seasonal workers and those workers so far have not been able to move freely because of the pandemic. So that should also normalise as the situation improves. On the energy side, it's perhaps a little more complicated. There is short-term volatility, with some of the energy stocks being low. But I think if we take a step back, and we look ahead at the future and the energy transition, then it's fair to say that for a while, energy prices are set to to continue rising. First because carbon prices will rise, so that people turn towards other energy sources, and so on. Because you want, when you're able, energy prices to rise a little as well so that investing in those energies is worthwhile. And that's something for which perhaps government could consider offsetting the shock for lower income households.

Mustafa 13:34

As the post Covid-19 recovery continues to unfold, consumers are realising that this is a rather expensive recovery. In addition to higher energy prices, food prices and commodities prices, housing prices are soaring. While most economic indicators deteriorated during 2020, house prices largely shrugged off the effects of the pandemic. According to the IMF’s Global House Price Index, an index that comprises over 60 countries, three-quarters of these countries saw increases in house prices during 2020. The upward trend is expected to continue well into 2022. Soaring house prices may not be a problem for now. But housing is certainly an area of concern, as central banks start moderating their fiscal and monetary support, which can only be a matter of time. Why are housing prices important? And why do housing and interest rates matter for the future of the economic recovery?

Ayesha 14:42

Laurence Boone, Chief Economist at the Organisation for Economic Co-operation and Development, OECD

14:48

Housing prices have been increasing for about a year and sometimes quite sharply. So it's not always obvious to find a link between housing prices and housing rental prices, for which the cost for consumers is elevated. What concerns us a little more with housing prices is when they rise too fast, when people buying houses are too much leveraged. Then, when interest rates start rising, you can see these prices go fast very quickly. And sometimes it's triggering a downturn. At the OECD, we've done a huge study on the role of housing for the cycle. So for that specifically, what we recommend is that public authorities actually use a lot more microprudential policy tools. So you're going to ask me what's that? And microprudential policy tools are instruments that people looking after the housing market have to try and limit the explosion of indebtedness to invest in housing. So for example, one can get a mortgage if the payment this person has to do every month is less than a third of what they're earning every month. And these types of tools usually help to assuage the markets, move things out and make sure that we don't have some kind of irrational exuberance on housing markets.

Mustafa 16:44

The economic recovery is strongly correlated to the pandemic. The new Omicron variant is yet another reminder of how a new strain could add uncertainties to an already uncertain situation, pushing some countries to reinstate travel bans, and causing more disruptions to the world economy. In this sense, what is transitory today could linger for longer than previously anticipated. But despite some setbacks, and in spite of a largely volatile situation, recent projections remain optimistic.

I’m Mustafa Alrawi and you're listening to a special podcast series from The National on the post-Covid-19 recovery, PCR.

In this episode, we're talking about money, or should I say the cost of the recovery and the value of money as inflation is rising to levels not seen in decades? One reason we're witnessing record high inflation rates and soaring prices is the massive government support during the pandemic.

The same sweeping relief packages that unleashed a torrent of money to bolster the recovery, are now weighing on the future of the recovery. Yes, that money was instrumental to helping households, workers and companies weather the crisis during the pandemic. Total US pandemic relief spending is set to hit more than 27 per cent of US GDP. That's taxpayers money. That's borrowed money. This is debt money.

In the UK from April 2020 to 2021, the government has borrowed £299 billion, the highest figure since records began in 1946. Another £200 billion will be borrowed until April 2022. Together the G20 countries, the 20 largest economies have spent around US$20 trillion in various support and relief schemes.

Ayesha 19:13

Laurence Boone, Chief Economist at the Organisation for Economic Co-operation and Development, OECD

19:20

It's true that this has been increasing with the Covid crisis. But, as we were discussing, it has actually been increasing for years, if not decades. And that hasn't necessarily been because governments have been spending into education or infrastructure, or healthcare systems or housing, that help people live better and push growth higher in the longer term.

So when that's not the case, we're a bit concerned that this money is being wasted.

So it was very right to spend during Covid, we have no issue with that.

But now that we're getting out of it, that the recovery is getting momentum, the one question people should ask is: What is all this public borrowing used for?

And again, we're saying, this public borrowing money should shift from support during the crisis towards investment for longer term growth. And again, that's investment in education, in infrastructure in healthcare systems, in things that will benefit, not only our generation, but our children and the children of our children, and so on. That's good debt.

And we're quite concerned that, as we get out of the crisis, governments will not do that but just get back to their pre-crisis habit, which was to spend but not necessarily on investment. That's for the sovereign debt.

And in terms of corporate debt, I think we should be very careful. It's normal that we have seen corporate debt increase during the crisis because, as you know, many governments and states have lent some money to firms to buffer the shock of Covid. So for many firms, their debt has increased, but their cash position has improved. Now, what we're concerned about is that the quality of the loans, looking ahead, may be uneven. Because obviously, in the emergency of the crisis, governments couldn't select where this money was going, to which firm they should be lending money. They just lent to everybody. But as we get out of the crisis, we are going to see some companies performing very well, or they're performing much less well and the quality of their credit will go down. And that, if it's very big, could obviously mean investors losing money and some disruption on financial markets.

Mustafa 22:11

Public debt levels, private and corporate indebtedness have sharply increased. This is not of great concern, as long as credit conditions are favourable, as long as central banks are keeping interest rates low. But what happens when central banks start raising interest rates? And governments cease support policies? Is there a reason to worry about historic debt levels? Would that compromise global growth in the medium to long term?

22:46

Post-World War II, the recoveries after economic crises were either the 20 per cent type so, over the course of the recovery, there was an aggregate economic growth of 20 per cent or 40 per cent types.

Ayesha 23:02

Martin Hurd, senior partner at McKinsey and Co

23:05

The difference, we believe, is something that we can learn from the global financial crisis. If you look at how the US handled it, where the US was stimulated quite strongly, and Europeans that played for austerity, it is very clear that the last decade was a decade in which the US in economic terms pulled ahead of Europe, more than they were before, because of that sustained stimulus, and the lack of a hard drive for austerity as long as you're in control of your own currency. And as long as there is no loss of faith in the government, and its ability to actually pay the interest, not the principal, on the debt, there is no real real concern. The only concern is, of course, inflation. But as long as inflation is as well under control as it was for the last decade or so, if you now observe our current situation, the real question is how long governments are going to sustain the stimulus. Is it going to be long enough in order to smoothly transition into a self-fuelled era of growth again? But it's not just the governments. It's also companies. Will they take the lessons from this crisis in terms of how to accelerate innovations? Will they hold on to the productivity gains that have been made through reduced staffing or remote work, which many people have benefited from and carry those into an era of accelerated growth through innovation and through accelerating productivity, growth and so forth? Or will people make conservative decisions and start slowing down again? Will governments stop the stimulus too early? And will we go into a more anaemic state, sort of type one growth, that 20 per cent type growth, until the next crisis? The question is still open. America is now starting to signal experiments. They have started to wind down the stimulus, the Fed has started to signal interest rate rises. We will see how that works out.

25:36

It's important to just focus on what folks are typically worrying about. And that's, you know, the size of the debt relative to the overall economy.

Ayesha 25:45

Ezra Greenberg, Partner, Strategy and Corporate Finance Practice at McKinsey and Co

25:51

In the conversation, it's important to remember that, that is actually a ratio. And many, many people focus on the level of debt and the amount of debt that was issued, and less so on what's happening. And it's nonlinear. That is, you know, growth of GDP. If you go back to the financial crisis, the outcomes that we saw in Europe, for example, which was a much more extended and deep crisis was largely because of the focus on the numerator and austerity and trying to eliminate debt. The truth is that over time across countries, in the entire post-war period, the way in which debt is best managed is through growth. And so the key here is to focus on trying to understand what can deliver healthy growth, and therefore, you know, drive that ratio down. That's how we got out of World War Two. And that's how most countries that have prospered have been able to deal with it. It's a controversial thing to say, but debt has never really paid off, right? It just reduces the size of the economy. And so I think it's good to focus on it, then understand what you need to do for growth. If it turns to actions that are focused on just austerity, then you get stuck at this kind of downward spiral of trying to cut your way out of something that you need to grow your way out of. And so that's really the danger and hopefully we've learnt the lesson from the financial crisis.

Mustafa 27:31

Economists tell us high inflation rates are a sign of the economy's comeback, and that inflation is predicted to start receding during 2022. Pressure is now building up as investors and economists urge central banks to step in and reverse inflationary trends. It is not so much a matter of when, as it is a question of how. How central banks and governments start exiting fiscal and monetary support policies will determine the future of the recovery. We can only hope that the transition will be smooth, and that the economic recovery is strong enough to self-sustain the momentum. Either way, we'll find out soon. 2021 was the year of the rebound. 2022 will most certainly be the year of the reckoning. We shall soon find out how sustainable the rebound is. Thank you for listening. If you enjoyed the show, please do subscribe on Apple Podcasts, Spotify, or wherever you get your audio content.

Updated: January 19th 2022, 7:20 AM