Reasons why inflation will remain low after the coronavirus crisis

In spite of surplus liquidity, low inflation rates are very likely.

Central banks are pouring vast amounts of liquidity into the markets to keep the economy afloat. However, there is no cause for concern that inflation rates will soar as a result. Low inflation and low interest rate levels are likely to remain.

Inflation likely to remain in check despite a flood of liquidity 

In the wake of the massive recession on the global financial markets due to the coronavirus crisis, the economy's fate lies mostly in the hands of government policy. In fact, there is no shortage of good reasons to believe in extensive stimulus measures and a rapid recovery. In light of the breakneck speed at which liquidity is being injected into the markets, however, many investors are worried about rising interest rates. But this fear seems to be unfounded.

In the short term, the crisis will result in one thing in particular: an excess supply of goods, services, and workers. Once the lockdowns are discontinued, we will have too much of everything – except, perhaps, certain medical supplies such as surgical masks or disinfectants. In the short term, this means price cuts and not price hikes. In this regard, the current recession is no exception to past ones.

Inflation in Switzerland has remained low despite the SNB measures

Furthermore, recent history tells us that, if anything, there is a weak and indirect relationship between printing money and inflation. For instance, the Swiss National Bank (SNB) has printed more than CHF 600 billion since the 2009 financial crisis. That's more than any other western central bank compared with their national economies. Nonetheless, Switzerland has the lowest interest rate of anywhere except perhaps Japan, which has a similarly expansionary monetary policy.

Inflation generally occurs in situations where companies can increase their prices. They do so because demand exceeds supply, because the supply suddenly disappears, or because market competition is non-transparent or limited by government regulation. It is very possible that the storage and manufacturing costs for many companies will rise due to the crisis.  However, first of all that would affect consumer prices only one time, and second, cost increases can rarely be passed on to consumers. On the contrary, they force companies to increase their productivity or cut their profit margins.

Investors must learn to live with low interest and inflation rates

A look at the history books also shows us that declining interest, returns, and inflation rates, which have investors wringing their hands at the moment, is not new. In fact, it is a structural process that can be traced back to the 14th century, as Paul Schmelzing, visiting scholar at the Bank of England, explains in a comprehensive working paper. There are generally three reasons for long-term declines in interest rates.

  • First, capital intensity increases over the course of history – and along with it, the economy's demand for capital.
  • Second, as people are having fewer children and living longer, this increases the supply of retirement capital invested for returns – which also causes real interest rates to drop.
  • Third, relative growth rates are declining as a result of absolute economic development.

The study thus contradicts the claim that low, and even negative, interest rates these days are unusual. Quite the contrary. Historically, they tend to be the norm. So we should get used to them rather than hoping for higher interest rates and returns. 

The long-term trend in industrialized nations favors low interest rates and inflation

Nominal interest rates for private loans and the resulting real interest rate trend, in %

Last data point: 2018

Source: Paul Schmelzing, Bank of England, Staff Working Paper No. 845

Past performance and financial market scenarios are not reliable indicators of future results.

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