Economic models have long been notoriously inaccurate at predicting inflation, and COVID-19 has further complicated the challenge. While economic forecasters calibrate their models using data from the past 50 years to explain and predict economic trends, current economic conditions are unprecedented in that period. Therefore, today’s low inflation forecasts do not guarantee that inflation will remain low. The pandemic may not be deflationary Even without additional inflationary pressure, reported inflation rates will increase significantly in the first five months of 2021. By May, UBS expects year-over-year inflation to rise above 3% in the United States and toward 2% in the euro zone, largely due to the low base in the first half of 2020, when the pandemic-related closures began. Therefore, the higher rate does not point to an increase in inflationary pressure, although an increase above those levels would be a warning sign. Breaking News: Wholesale Inflation Records Highest Increase Since 2009, PPI Shows, But Unlikely To Sustain Many argue that the COVID-19 crisis is deflationary, because pandemic mitigation measures have affected aggregate demand for more adversely than aggregate supply. In the first months of the crisis, this was largely the case: in April 2020, for example, oil prices fell towards zero or even below zero. But a close look at supply and demand reveals a more nuanced picture. In particular, the pandemic has shifted demand for services to goods, some of which have become more expensive due to production and transportation obstacles. In current consumer price calculations, rising prices for goods are partly offset by falling prices for services such as air travel. But in reality, restrictions related to the pandemic mean that consumption of many services has fallen dramatically; for example, significantly fewer people fly. The real consumption baskets of many people have become more expensive than the basket used by statistical authorities to calculate inflation. Therefore, actual inflation rates today are typically higher than official figures, as reports have confirmed. Once governments lift mobility restrictions, service inflation may also rise if capacity reduction, as a result of permanent restaurant and hotel closures, for example, or airline layoffs, is insufficient to meet demand. . COVID-19 may pose an even higher inflation risk. According to UBS estimates, aggregate government deficits amounted to 11% of global gross domestic product in 2020, more than three times the average of the previous 10 years. Central bank balance sheets rose even more last year, by 13% of world GDP. Therefore, the public deficits of 2020 were indirectly financed through the issuance of new money. But this will only work if enough savers and investors are willing to keep money and government bonds at zero or negative interest rates. If doubts about the soundness of these investments prompted savers and investors to switch to other assets, the currencies of the affected countries would weaken, leading to higher consumer prices. Breaking News: World Debt Increased More During the Pandemic Than During the 2008 Financial Crisis, IIF Finds Previous episodes of excessive government debt almost always ended with high inflation. Inflation caused by a loss of confidence can arise quickly and, in some cases, at a time of underemployment, without a prior spiral of prices and wages. Although expansionary monetary policy after the 2008 global financial crisis did not lead to a rise in inflation, this does not guarantee that price growth will remain low this time. After 2008, the newly created liquidity flowed mainly to financial markets. But the current expansion of central bank balance sheets is causing large flows of money to the real economy, through record fiscal deficits and rapid credit growth in many countries. In addition, the monetary policy response to the pandemic was much faster and more substantial than in the last crisis Structural factors Demographic changes, increasing protectionism and the de facto increase of the Federal Reserve last year from its inflation target of 2 % are other factors that could lead to higher inflation in the long run. Although these structural factors are unlikely to trigger a surge in price growth in the short term, they could still facilitate it. A sharp rise in inflation could have devastating consequences. To contain it, central banks would have to raise interest rates, creating financing problems for heavily indebted governments, businesses and households. Historically, most central banks have been unable to resist government pressure for sustained budget funding. This has often led to very high inflation rates, accompanied by large losses in the real value of most asset classes and political and social upheaval. In recent months, commodity prices, international transportation costs, stocks, and bitcoin have risen sharply, and the US dollar, BUXX, + 0.23% has depreciated significantly. These could be harbingers of a surge in consumer prices in the dollar area. With inflation rates highly correlated internationally, higher inflation in the dollar area would accelerate price growth around the world. Watching the markets: Dow pulls back as rising bond yields and inflation fears spook the stock market. Too many are underestimating the risk of rising inflation, and optimistic model-based forecasts do nothing to ease my fears. Those responsible for monetary and fiscal policies, as well as savers and investors, must not get caught. In 2014, former Fed Chairman Alan Greenspan predicted that inflation would eventually have to rise, calling the Fed’s balance sheet “a lot of tinder.” The pandemic could well be the lightning bolt that ignites it. This comment was posted with permission from Project Syndicate: Will inflation return? Axel A. Weber, former Chairman of the Deutsche Bundesbank and former member of the Governing Council of the European Central Bank, is Chairman of the Board of Directors of UBS Group AG.