In focus

The inflation debate: the deflationary forces being overlooked

There are many deflationary forces at work in the global economy. These suggest that the current bout of inflation will, ultimately, prove transitory. This is the counter argument to our alternative imagined look at inflation: The view from 2030: how transitory inflation became permanent in the “roaring 2020s”.

Some key deflationary forces are:

>Technology and innovation

>Fiscal dynamics

>Labour market slack

>Ongoing globalisation

High levels of investment, particularly in new technologies, could lead to greater productivity growth justifying some of the wage increases which have been driving fears that inflationary pressures will persist. New investment in robotics, particularly combined with AI, has potential to lower costs and prices. Autonomous vehicles could be a key deflationary force.

You can watch the argument for deflation in full by clicking the play button on the video at the top of the screen.

Central banks are being forced to normalise interest rates in order to bring near-term inflation under control, this will have important implications from the perspective of fiscal dynamics. Higher debt servicing costs will eventually feed through into higher government debts and we expect governments will need to introduce austerity measures as a result. Such measures are deflationary.

Despite aging populations in many countries we think there is some hidden slack in labour markets. India in particular has a young population just entering its prime and these favourable demographics are often ignored in analysis of global labour markets. Additionally, the potential for greater female participation rates in many middle income countries should not be underestimated.

Globalisation still has a big role to play in lowering costs as production shifts to new countries. The recent trend towards onshoring is unlikely to be a permanent one. At the same time, governments are likely to remain focused on competitiveness and increasing productivity, which also has the potential to further lower costs and inflation.

More widely, governments are realising that the only sustainable way to increase wages is with higher productivity growth and green fiscal initiatives. And we expect central banks to become less tolerant of inflation as political imperatives could test their independence and use of monetary policies which have driven up asset prices and exacerbated wealth inequalities.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.