Is Inflation Killing Productivity?
It may be that as I get older, I become nostalgic for what my children call ‘the olden times’ (when I was a twenty something). In that spirit a friend, with much the same age and background came to visit recently, and we spent some time discussing ‘university and the research methods’ of the 1990’s economics field.
At the time, in order to undertake quantitative research project, I had to write a 15 metre long computer program, which like a good dish I would leave overnight whilst the program would (from my local faculty computer) dial into a computer at the London School of Economics, borrow some data and analyse it, returning raw regression results to me the next morning (statistical packages like Stata and EViews would follow later).
If there was a problem with either the data or the program, I had to wait till the next evening to rerun the program. That computers in different countries could talk to each other, was relatively novel. Today, such an operation might take a fraction of the time.
Back then, if one wanted to consult a piece of research, often the fastest way of doing so was through inter library loan – a system where a written request was made by one library to another in a different university, and where a photocopied version of the research paper was sent by post. Little wonder then that when Netscape arrived, people tended to conceive of it as a ‘world library’.
That all this happened in the mid to late 1990’s will date me, and I hope show younger generations that research and discovery existed before social media and were generally more interesting as a result. Travel and communication were different also. I can recall relying on pigeon post to organise nights out or arranging holidays with promises to ‘see you on the Charles Bridge (Prague) at 7pm in three week’s time’.
Before I sound too sentimental or old fashioned, I want to stress two points. The first, which I also underlined last week is that humanity is at a crucial point where it is being challenged by technology – our ability to contemplate is challenged by over-stimulation, and our sociability is challenged by the virtual.
The second point is that what really had me thinking about the ‘olden times’ is the bond market. The mid 1990’s was really the last period of sustained high interest rates (having risen sharply in 1994 the Fed Funds rate stayed above 5% till the dot.com recession in 2001). Further, in finance and economics textbooks of the time, as well as banking valuation models, one was always told to use a reference long bond yield of 3.5%.
In today’s increasingly nervy market climate, where inflation in both Europe and the US is spiking to multi-decade highs, the possibility of a fed funds rate of 1% by next year seems profoundly off-putting. One can only imagine the reaction if we went back to 5%, á la the ‘olden times’.
Without going through the boring exercise of trying to forecast inflation (my view is that service price and wage inflation will stay sticky for the next year, though commodity inflation – oil, semiconductors, lumber etc – is peaking), I want to note that the most interesting element of these multi-decade turning points is the psychological one.
People like me whose view of financial theory and practice was formed in the period up to the global financial crisis, have difficulty understanding the co-existence of 7% headline inflation, zero interest rates (and 1.7% long bond yields) and record high stock market valuations. Against the benchmark of decades of financial history, it makes little sense, except that central banks decree that it does.
On the other hand, younger people, who may have come into markets since 2007 will find all of this to be normal – rates will stay low, returns will be high and liquidity can only but be plentiful. This is perhaps where the greatest risk lies in markets, that a significant generation of investors are unused to the kinds of forces that have riled economies in the past (rising inflation and subsequently, interest rates).
The other difficulty, which I find relegated in the broader debate over inflation and supply chains (a good overview from the CFR here) is productivity. Once the economic fog of the coronavirus crisis lifts, governments will have to zero in on productivity as the driver of growth. My stories from the ‘olden times’ are good illustrations as to how far computing power and the data industry have come, and the extent to which they have contributed to large productivity gains.
However, what is remarkable about the past fifteen years is that in certain large economies, Italy, Britain and even the US for instance, productivity has collapsed. It is not clear why this is the case – low investment, inefficient or lopsided digitization or long (and thus inefficient) business cycles are some of the factors I can think of. Neither is it clear to what extent the many new technologies (see last week’s note), and approaches to work (zero-hours, work from home) we are witnessing will boost productivity, or turn out less productive humans.
This will be the biggest economic policy challenge of the next decade.