While it is relatively easy to predict that the post-corona economy will suffer from high unemployment, the outlook for price inflation is not so certain. On the one hand, there will be high government deficits and more public debt; on the other hand, given the weak economy, consumers and companies may refrain from taking on new debt and could begin to lower their debt burden.
Monetary Expansion Doesn’t Always Lead to Price Inflation
In contrast to common usage, the correct use of the term “inflation” refers to the money supply. Rising prices are not the cause, but the result of monetary expansion. However, not every rise of the money supply turns into price inflation. It can happen that the so-called price level remains stable when there are drastic shifts in the demand for goods and services that impact differently on their prices. The average will be deceiving when rising and falling prices cancel each other out and when certain goods and service vanish from the statistical basket because prices have risen so much that the demand has collapsed.
Due to the immense disruptions caused by the lockdown of the economy and because of social distancing, fundamental structural changes in business life are going on. More goods and services will be removed from the official price statistics than usual, and for those products that remain in the basket, prices may vary widely.
Problems with Measures of Price Inflation
Even more than in the past, the statistics of the price index will send wrong signals about the extent of price inflation. If the prices for some goods rise exorbitantly and, accordingly, there is less demand, they go into the statistical shopping basket with a lower weight, and these goods can drop out completely if they are hardly in demand because they have become too expensive for normal consumers. Even more than in the past, price inflation, measured by the statistical price index, will no longer be a reliable guide for monetary policy—if this has ever been the case.
Inasmuch as modern central banks follow the policy concept of “inflation targeting,” they will lose a reliable compass.