Aperiodic – no.

21/394 – 16th December 2021

The point of view

The risk may not be what you think it is

All eyes are on inflation numbers, which continue to surprise to the upside to the point where one might
wonder whether the global economy has switched to a new regime of inflation after living so long with the
risk of the converse: deflation.

This feverish surge in prices is mainly driven by cyclical factors resulting from an imbalance between,
on the one hand, frenetic consumer spending now that economies have come out of the deep freeze, and
on the other, the inability of production capacity to keep pace, in some cases due to the reimposition of public
health restrictions in places where the virus continues to run rampant. Bottlenecks, shortages of materials
and electronic components, a sharp rise in energy demand and global supply chain disruption are the visible
symptoms, with production costs soaring in the face of now price-inelastic demand. This overconsumption
is nevertheless set to disappear as post-Covid catch-up effects fade away, easing demand-side
pressure. Meanwhile, supply remains shackled by public health restrictions, particularly in China, where the
government’s zero-Covid policy could yet further disrupt the economy. But however long this temporary
situation drags on, major central banks cannot leverage disrupted global supply, and the need to rebalance
supply and demand could necessitate putting the brakes on demand at the risk of flirting with recession – a
hard pill to swallow, hence the currently rather salutary tendency to procrastinate.

However, this patience could be put to the test if accelerating wage growth fuels excess demand, with the
risk of second-round effects taking hold if prices and wages are both rising at the same time. Despite
unemployment rates still being above pre-pandemic levels as countries emerge from the crisis, strain
is already beginning to show on labour markets, with growing numbers of businesses reporting
hiring difficulties or labour shortages. This phenomenon has been particularly acute in the United States,
where the number of people leaving the working population, mostly to take early retirement, is aggravating
shortages and leading to record levels of resignations encouraged – especially in sectors facing skills
shortages – by a mobility premium that is causing starting salaries to skyrocket. Some see this “great
resignation” as the prelude to a more far-reaching paradigm shift to a post-Covid world in which low earners
exact their revenge. It’s certainly true that, in this supposedly highly flexible economy supercharged by
oversized stimulus packages, where the distribution of added value has long been skewed in favour of profits
against a backdrop of soaring inequality, restoring some negotiating power to workers could speed up the
salary adjustment process. But however desirable this may be, it carries a risk of unleashing runaway
inflation. In Europe, firms are also complaining of difficulties recruiting and feel frustrated at the impact the
lack of personnel is having on their business. These tensions should, however, ease, with new job creation
slowing as demand and production conditions normalise. While catch-up pay rises after two lean years and
the legitimate need for rises in sectors facing skills shortages mean wage increases are to be expected, any
uncontrolled rise is likely to run into the buffer of company margins: with end consumers seriously concerned
about their purchasing power, businesses’ ability to pass on such cost increases is limited.

In any event, central banks continue to hammer home the message that growth will eventually slow
from its current levels and bring down inflation with it, even if the timescale for this scenario is
constantly being pushed back. This kind of willing optimism masks a growing discomfort with the difficult
trade-off that must be made between monetary and financial stability. Siphoning off liquidity and hiking
interest rates to bring inflation back under control would be tantamount to depriving markets of oxygen, with

Group Economic Research

https://etudes-economiques.credit-agricole.com
The point of view
The risk may not be what you think it is

the risk of triggering a downswing that could cause expectations to abruptly swing from euphoria to panic as
investors all try to flee for the exits and turn their assets into cash at the same time. In a world overloaded
with debt, such financial swings carry within them the seeds of deflation: the purge of financial excesses risks
setting in motion a vicious circle in which declining asset prices, confidence, economic activity and prices all
feed off each other.

Central banks are thus walking a tightrope: they must deftly negotiate the withdrawal of emergency
monetary policies so as to calm the necessary overheat, but they must do so without throwing
markets into a panic and causing the economy to swing from an inflationary regime to a deflationary
one. 

Isabelle Job-Bazille
Isabelle.job@credit-agricole-sa.fr

No. 21/394 – 16th December 2021 2

The point of view
The risk may not be what you think it is

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No. 21/394 – 16th December 2021 3