INFLATION'S HAUNTING EFFECTS
If and when inflation is under control, it doesn’t mean its effects won’t still be felt for years afterwards. A paper co-authored by BNY Mellon Investment Management’s chief economist, Tidal Forces: Dissecting the interest rate equation, highlights it took some 15 years to shake off the spectre of the high inflation of the 1970s.
When inflation has been high for some time, an inflationary “psychology” emerges, Shamik Dhar explains, resulting in even higher nominal interest rates required to get inflation back down.
“It took a long time to break the inflationary psychology of the 1970s, so interest rates stayed high for a long time. Arguably, it wasn’t until the late 1990s that this battle was won. And no sooner had it been won, than inflationary pressure started to move in the other direction, thanks to forces like globalisation and China’s integration into world manufacturing markets.”
Then came the financial crisis in 2008 and the extraordinary period of zero interest rates and quantitative easing programmes. He adds: “Once again, it took a long time to counter this mindset and arguably required other huge shocks – the Covid pandemic and the Russia/Ukraine war – to start to reverse it. All this suggests real interest rates are fundamentally affected by low-frequency swings in inflationary pressure and inflation psychology.”