It’s often said you don’t realise how good something is until it’s gone. This may apply to the low inflation environment that prevailed up to the pandemic. Apart from a few nasty interruptions this saw a downtrend in interest rates, mostly low unemployment, and an upwards trend in asset values (albeit it wasn’t so good for housing affordability). The explosion in inflation over the last year and the associated surge in interest rates and slump in investment markets makes it all seem like a distant memory.
The good news is that, as we noted in our last note, there is reason to believe the short term surge in inflation may be peaking (led by the US) & this, along with various other factors, may result in a better cyclical outlook for shares over the next 12 months. The bad news, as we have noted in various reports, is that we have likely seen the bottom in the long-term decline in inflation from the early 1980s and inflation is likely to be higher over the medium term than pre-pandemic. This note takes a look at the five key structural factors driving this.
1. Bigger govt, less economic rationalist policies
The reaction to the inflationary malaise of the 1970s was the economic rationalist policies of Margaret Thatcher, Ronald Reagan and Bob Hawke and Paul Keating in Australia. These focussed on boosting the ability of the economy to supply goods and services by: limiting government involvement in the economy through policies such as deregulation and privatisation; policies to boost competition; measures to boost incentives by lowering tax rates; and labour market reform to make labour markets more flexible. This all helped lower inflation. Now as a result of the problems highlighted by the GFC, rising inequality, stagnant wages, aging populations, climate concerns and a collective memory loss regarding the lessons of the past there is a backlash against economic rationalist policies and more support for government intervention in the economy. It’s evident in Australia, for example, with the rising trend in government spending and revenue as a share of the economy, widespread pressure to raise taxes, together with measures to return to multi-industry bargaining within the labour market. The risk is that greater government involvement in the economy leads to lower productivity growth which will hamper the supply side of the economy and add to inflationary pressure.