The world faces the deepest global recession since at least the 1930s Great Depression. But when activity returns to a new normal, will the disruptions to demand and supply and the unprecedented monetary and fiscal stimulus unleash a resurgence of inflation?

The biggest and quickest ever monetary and fiscal packages are not a traditional ‘pump-priming’ stimulus to raise demand, but are aimed at trying keep people and companies afloat financially during the pandemic.

Even so, business investment has fallen sharply and households plan to reduce borrowing so spending looks set to remain extremely weak.

The near-term inflation outlook is clear – it is heading even lower. The collapse in oil prices and discounting by companies keen to boost sales should more than offset higher food prices to turn Eurozone and US inflation negative this summer.

But if businesses fail – including restaurants or even airlines – the reduced competition could see the survivors raise prices over the next year or two. Supply-chain disruptions may also push up prices. So after hitting new lows by mid-2020, headline inflation will be notably higher in 12 to 15 months as demand increases and oil recovers.

Many households’ savings have risen during the lockdowns and pent-up demand as sectors re-open may produce an initial bounce in spending, but consumers could take time to regain confidence, especially if the rise in unemployment is slow to reverse, and some lockdown habits may stick.

But for the medium term, we expect inflation expectations to remain structurally low. True, rising nationalism and protectionism threaten the globalisation effects that have lowered many prices over the past two decades, but that would squeeze spending and prices in other areas, especially discretionary services.

A sustainable rise in headline inflation would require higher wage growth not backed by productivity, and with unemployment significantly above pre-pandemic rates, that is unlikely.

That said, Latin America and Turkey are set to remain higher-inflation economies and South Africa’s poor public finances means it may join them. But inflation should remain low across most of Asia. Indeed, the deflation risk that haunted China during 2018-19 could re-surface.

But one risk in the advanced economies is that – by accident or design – the huge policy stimulus ultimately results in inflation.

Governments cannot shift sharply from stimulus to austerity once the lockdowns cease. Support must continue until the recovery is assured. But if they underestimate the pandemic’s permanent damage to supply and stimulate demand too much, inflation will follow. Or if the permanent loss to supply proves minimal and consumer spending remains low, then the extra slack in the economy from failing to stimulate demand sufficiently could result in below-target inflation or even outright deflation.

There is also a risk of a concerted determination by governments to inflate away the large public debt by deliberately running persistently loose fiscal policy backed by central banks to ensure persistently negative real rates.

First published 4 May 2020.

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