The 10 most critical market questions on inflation

In the first report of the series, ÃÛ¶¹ÊÓƵ’s Global Economics analysts address the most important questions received from investors on the much debated topic of inflation. Our baseline expectation lands well below central bank targets early next year but we now see more upside than downside risk.

  1. Is this time really different?
  2. Will the vaccine create massive service price normalization effects?
  3. Will the global surge in liquidity cause inflation?
  4. Is "excess demand" really a risk for inflation?
  5. Are Phillips curves useful in predicting the post-pandemic inflation trajectory?
  6. Are inflation expectations becoming unanchored?
  7. How worried should we be about rising commodity prices and shipping costs?
  8. Breakeven vs realized inflation: common or distinct drivers?
  9. Is there a global inflation cycle, and how central are the US and China?
  10. Does a booming housing market create a risk of a surge in rents in the US?

Quantifying what matters

The compendium dispels some widely held myths, for example there is no such thing as 'an inflation cycle' once you control for commodities; the US and China don't drive global inflation; and we explain why there is zero relationship between liquidity and inflation. But it also quantifies some of the things that do matter. For instance, we show that the importance of the current global container shortage is small but may actually be on par with the amount of inflation generated by standard Phillips curve models.

But the most striking estimates are perhaps on 'pandemic normalization' effects: they are 10 times more important than the amount of inflation we believe you could reasonably expect from output gap closure (putting the US stimulus/excess demand debate in context). However, contrary to popular belief, the risk is not just to the upside; in the US, for instance, the basket of goods/services that could correct to the downside is of roughly equal size as the basket that could correct to the upside. We also show how we only need to be a little bit wrong on the US housing market to reach the Fed's inflation target by end 2021 rather than end 2023.