Inflation Risks More Balanced, But Not By Much
Michael Ashton | Jun 06, 2012 12:55AM ET
The G-7 finance minister/central banker call came and went yesterday with no earth-shattering announcement. In a statement, here ) that money velocity is reasonably well-correlated to changes in the provision of bank credit. The updated chart from that article is below (Source: Enduring Investments), and if the quarter ended today the 2-year compounded rise in commercial bank credit would be up around 2.5%, implying that something like a 17% increase in velocity is expected (eyeballing from the chart).
This does suggest a possibility, though, and a way that deflationists could be right. If commercial bank credit collapsed again, then I would expect velocity to keep on contracting.
My argument about the upside risks to inflation – at least, the long-tail possibilities – depends on a rebound in money velocity that is not countered by aggressive tightening. We are not going to get aggressive tightening, certainly. But there is a possibility that credit could seize again, as it did in late 2008.
Certainly, this is a reasonably likely outcome with European banks. The question is whether U.S. banks – which are much healthier now and currently increasing lending at a 6% clip versus 52 weeks ago – Canadian banks, Japanese banks, etcetera could pick up enough of the slack (or whether European regulators would allow or even encourage zombie banks to keep lending once they become effectively wards of the state) to offset this.
If policymakers get any inkling that credit is seizing up, then the monetary spigots will open wide once more, so in my view a deflationary outcome is very unlikely. But in fairness, such a downside tail is more of a possibility than it was a year ago. Is it possible that central bankers might stand down even as velocity plunges? It’s possible, now that there is some concern about the sizes of central bank balance sheets – but I don’t think it’s very likely.
So in my opinion, the possible downside “deflation” tail is short in length, short in duration, and low in likelihood; the possible upside “inflation” tail is quite long, quite long in duration, and not nearly as unlikely…in a world where monetary tightening is not viewed as feasible.
I’ll go further and say that if I had to hazard a guess, I would guess that five years from now, we will giggle when we think back and recall that we were concerned about whether our “entry point” for long-inflation trades was 2.10% or 2.40% on ten-year inflation.
Get The News You Want
Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.