Inflation: Friend Or Foe?

Unfortunately, we are currently in the middle of a global pandemic and the fiscal policies merely try to absorb the negative effects of the pandemic on the economy. This means that the policies only fill holes rather than stimulate growth. Since prices are sticky and only adapt slowly (even more so on the downside), the measures come in when prices remain the same. Thus, the monetary expansion falls flat and the prices increase, just as the uncertainty about the future value of our money. In the figure below, we can see that the so-called “demand-pull” inflation. Here, the starting point is E0. The fiscal policies increase the demand (AD0 -> AD1). Ideally, this creates economic growth and the GDP increases from Y0 to Y1. The supply (AS0) needs to remain stable, however. 

Mix Inflation Chart

The problem is that many companies needed to restructure their businesses and these changes were, in part, quite fundamental. Changes of such a large scale within such a short period of time consume massive monetary means. The additional help from governments only cover a small part of those changes and often not even the incurred losses. Additionally, the political elites of the USA continues to press for higher taxation of companies, which would increase the burden on companies. AS0 becomes AS1 and leads to higher prices without moving us away from Y0 in the end.

In the next graph, there is an example of healthy inflation. Here, we can see that the long-term aggregate supply increases (LRAS1 -> LRAS2). This does not simply happen by itself. Through technological advances, innovations, better economic circumstances, and external factors, the total economic potential is increased. As an example, we could think of a sudden increase of immigrants who increase the human capital of an economy. Likewise, we can think about the emergence of the internet, which heavily increased the economic output globally.

LRAS Chart

Thus, whether inflation is our friend or foe is strongly influenced by the overall situation and our own perspective. Regarding the growth and technology stocks, which incurred heavy losses over the last couple of days, there are fears of future value decline, as the expansive monetary policy does little to foster growth while reducing monetary value through inflation. Therefore, instead of progressive growth, the capital markets turn towards a more status quo solution to bridge the current low by turning towards more cyclical assets. What is clear, however, is that the sustainable value increase will always be the single most important aspect of the stock market in the long run.

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