Will the pandemic be inflationary or disinflationary?

Will the pandemic be inflationary or disinflationary?

 A look into the pandemic’s effect on all economic agents and their responses

The pandemic. The impact it will have on the world is yet to be fully calculated. It has caused governments to issue lockdowns worldwide, urging millions to stay home in order to control the disease. The government is in conflict whether to put their focus on their population’s health or the economy, which has meant coming to a compromise that may lead to the pandemic becoming disinflationary in the long term, looking at various sources and analysis. The response to the pandemic as well as the message given to the general public has led to a fall in aggregate demand as well as a large rise in unemployment. When aggregate demand falls, it can mean low and even negative economic growth, which in turn leads to disinflation, and in its extreme, deflation. However, deflation is very unlikely, because as ‘the Economist’ (Anon., 2020) has pointed out, governments have embedded inflation into their policies, and once the situation returns to its former level, it will mean slow inflation across the world.

The first and primary repercussion for the economy is a fall in aggregate demand because people are warier whenever they decide to spend. This was predictable, though, because the pandemic has struck fear into the world, and people are more likely to keep precautionary savings for a ‘rainy day’ rather than spend as easily as they used to. This impacts both the buyers and sellers in the market, so firms would also suffer from this. Another key reason for the declining consumer confidence is the fact that individuals fear that a recession will occur in the future, making them more likely to save rather than spend. Hence the very threat of a recession leads to recession as well as disinflation in the present, as the rate of increase of the price level falls when goods and services are not bought.

 Moreover, the pandemic means that businesses have had to restructure their staff as a result of new restrictions causing unemployment to rise uncontrollably. As a consequence, people have less real disposable income which causes consumption, which is a component of aggregate demand, to fall. This is likely to reduce the general price level rising as a whole because many industries have seen a decline in output and sales.

This includes air travel, where British Airways have said that they could cut about 12,000 jobs as a result of the ‘collapse in air travel’ (Leggett, 2020), according to BBC News. They have also said that it could take at least a few years for air travel to return to pre-pandemic levels, which exemplifies just how cautious people have become, and how the economy is going to be affected. Other industries include the retail industry, where firms such as the Arcadia Group as well as Debenhams have seen losses and are now facing severe bankruptcies which could go ‘from bad to worse’ (Danziger, 2020). The source shows the staggering number of retail bankruptcies across the world that have occurred, and the fact that there are more to come. This could be because people do not see goods such as clothes and fashion as a necessity anymore, staying at home. It also acts as a signal for the public, and can significantly decrease consumer confidence that has the effect explained above.                                                       

 On the other hand, it is also important to take into account that we have been able to develop a vaccine at the quickest rate in history against a pandemic, which is definitely able to give people hope after a long period of low productivity. This would increase consumer confidence, which would make them more comfortable to start spending. This would in turn increase business confidence to invest, as they would be making more revenue from increased sales. Nevertheless, we must also remember the fact that low productivity in firms would mean they might be unable to keep up with a sudden rise in demand. Therefore, cost-push inflation is likely to occur. Demand will continue to rise as people slowly start returning to work, physically or virtually. Indeed, many firms will decide to put importance on working virtually, where many have previously been working from home as well. This would also affect firms’ costs and would influence the market and consumer demand.

 In addition, certain industries have also had a massive flourish in sales. This includes groceries, pharmaceuticals and home entertainment/media since people have constantly been looking for entertainment during lockdown. In fact, every time the government announces a lockdown, thousands begin to frantically stock as many daily necessities as they can, being aware of the fact that once lockdown begins, they will find it difficult to travel to grocery stores as they formerly did. The flourishing ones would have balanced the declining sectors, and at this point, we would have to go in more depth and look at the CPI index (Powell & Powell, 2015) to decide whether it will be inflation or disinflation that would really occur. Judging by it, a larger percentage goes to the parts that have seen a decline such as transport (having a CPI weight of 15.2%) and recreation/culture (CPI weight 14.4%), making disinflation more likely.

 Nevertheless, many people may have lost their jobs permanently, not to mention being hit by structural unemployment as industries collapse when most businesses decide to move online, as well as adapt more capital-intensive methods that are friendlier with new restrictions. In addition, many people would have lost their skillset after being out of work for so long, and may be faced with occupational immobility. This would therefore lead to disinflation, because people are left with less income and expenditure falls. This may seem like a more short-term impact rather than long term, because capital-intensive methods would open new job opportunities, and people are likely to improve on their skills over time.  However, looking at the industries where people have lost their jobs, the individuals are not likely to have transferable skills, so unless the government sets up new education schemes (which has its own opportunity costs), reemployment is going to be a time consuming process. This is likely to result in disinflation as firms throughout the country are forced to lower prices, for survival as well as to meet the decreased disposable income of thousands of people.

 The Bank of England minutes of meeting that occurred on 17 December 2020 shows that the Bank Rate has remained at 0.1% (Anon., 2020). This implies that demand is still low and is likely to remain low for many years as was done after the 2008 recession. It is clear that they are trying to use this as a stimulus for aggregate demand, as they did with the recession because disinflation is likely to occur. This is used as a stimulus because it allows interest rates to remain low which encourages investment.

 As well as keeping the Bank Rate low, government spending on the public sector has had no limit this past year. This includes the furlough scheme (Lawrie, 2021) put in place by Chancellor Rishi Sunak (which was extended), as well as the ‘eat out to help out’ scheme where the government paid for half the costs of eating in a restaurant. While this was necessary to make sure that the economy does not completely collapse, it has meant that the budget deficit of the UK, which contributes to national debt, has skyrocketed, while it was already at 84.7% as a proportion of GDP (Munro, 2020). In addition, the government’s tax revenue also decreases since individuals pay less income tax, and firms pay less corporation tax and VAT after a decrease in sales. A combination of falling tax revenue and increasing government spending increases the budget deficit. In order to pay this back, the government would eventually have to raise taxes and lower government spending, which further reduces aggregate demand and causes disinflation, something similar to the fiscal austerity the Conservatives adapted in 2010 to pay back the national debt accumulated when the Labour Party had been in power.

 The monetary policy that the Bank of England is using does not only affect consumption; it can also influence net exports as well as investment, which is primarily done by firms. Another impact of low interest rates is that the pound sterling’s exchange rate decreases, which is likely to increase the price competitiveness of UK exports in world markets, making foreign customers find UK goods cheaper. Imports simultaneously become more expensive for UK consumers, leading to an overall increase in net exports, which again increases aggregate demand. Given that this leads to inflation, it implies that the Bank of England is attempting to achieve this, since disinflation is most likely to occur. Although the UK becomes price competitive, other countries are unlikely to trade with the UK given the level that the virus has spread and the UK’s inability to comfortably resume their economic activity.

 In terms of the UK specifically, it is faced with additional challenges such as Brexit, where even though Prime Minister Boris Johnson has finally negotiated a deal, it does not necessarily mean the best for the UK. This is also a contributing factor for the increasing likelihood for disinflation to occur because of lack of confidence in trade, investment and productivity, which forces the price level to increase at a much slower pace.

 Looking at the situation globally, economies in Asia are likely to see faster recovery and inflation in their economies nonetheless. This is due to how well countries such as China, Vietnam and South Korea have been able to control the virus, which could have been for a number of reasons, namely them having more experience in dealing with such issues having faced the Sars epidemic previously. The government as well as the people responded efficiently, which is why they have been able to start economic activity so relatively quickly in comparison with Europe and the USA. These have fared far worse in their actions and we can see the consequences of this right now in the UK where we are unable to go back to normal with certainty. Not to mention the USA, which have seen the highest number of cases worldwide. Disinflation is much more likely to occur there because of this as governments issue lockdowns and strict restrictions regularly. While this is necessary given the speed at which a new strain of the virus forms, it constantly disrupts output for these economies as well as increasing the chances of unemployment by acting as a recurring obstacle for economic growth.

 Overall, economies are now likely to be inward looking in terms of decision making due to the contrasting challenges faced worldwide. This poses a challenge for us all, one that is likely to result in decreased economic activity given how interdependent and globalised the entire world is. As we have seen in the past with the 2008 recession and even further, in the Great Depression - if countries such as the UK or the USA are reeling in economic downturns it impacts the rest of the world.

 Regardless of what the general population thinks, we are nowhere near the end of the pandemic and most industry experts and firms have warned that they will take at least a few years to return to pre-pandemic levels. The government has also warned that ‘the UK could experience at least three waves with lockdowns’ (Elgot & Stewart, 2020). This would mean a constantly fluctuating situation, in which it is unlikely that behaviour is likely to be higher or even the same as previous levels. Slow inflation will definitely occur in the future given the monetary policies used by the government and the Bank of England, but at a slower rate than pre-pandemic levels. The situation is such that we may have to adapt permanently to an alternate definition of normalcy if we are to escape the pandemic, which is why I believe that the pandemic is likely to be disinflationary as a whole, in the long run.

Bibliography

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References

Anon., 2020. Bank Rate. [Online]
Available at: https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2020/december-2020
[Accessed 28 December 2020].

Anon., 2020. News and Events. [Online]
Available at: https://www.ox.ac.uk/news/2020-11-23-oxford-university-breakthrough-global-covid-19-vaccine
[Accessed 10 January 2021].

Anon., 2020. Will inflation return?. The Economist, 12 December, p. 15.

Anon., 2021. The Brexit deal. The Economist, 2 January, pp. 16-17.

Danziger, P. N., 2020. Retail Bankruptcies. [Online]
Available at: https://www.forbes.com/sites/pamdanziger/2020/10/07/retail-bankruptcies-will-go-from-bad-to-worse-in-2021/?sh=364fc003b07e
[Accessed 5 January 2021].

Elgot, J. & Stewart, H., 2020. UK Politics. [Online]
Available at: https://www.theguardian.com/politics/2020/nov/03/uk-can-expect-three-more-covid-waves-with-lockdowns-mordaunt-says
[Accessed 27 December 2020].

Jack, S., 2020. Business. [Online]
Available at: https://www.bbc.co.uk/news/business-55139369
[Accessed 30 December 2020].

Lawrie, E., 2021. BBC News Explainers. [Online]
Available at: https://www.bbc.co.uk/news/explainers-52135342
[Accessed 10 January 2021].

Leggett, T., 2020. Business. [Online]
Available at: https://www.bbc.co.uk/news/business-52462660
[Accessed 6 January 2021].

Munro, F., 2020. UK Government debt and deficit. [Online]

Available at: https://www.ons.gov.uk/economy/governmentpublicsectorandtaxes/publicspending

 

[Accessed 7 January 2021].

Powell, J. & Powell, R., 2016. AQA A-level Economics Book 2. London: Hodder Education.

Powell, R. & Powell, J., 2015. CPI shopping basket. In: AQA Economics for A-level Year 1 and AS. London: Hodder Education, pp. 156-157.

Powell, R. & Powell, J., 2015. Labour's fiscal stimulus gives way to Coalition fiscal restraint. In: AQA Economics for A-level Year 1 and AS. London: Hodder Education, pp. 211-212.