The COVID-19 infection rate seems to be flattening and starting to reduce notably here in Australia. Some are starting to ask how long virus containment measures need to stay in place, and what staged process of relaxation is possible to avoid a renewed flare up of infections. Medical experts are considering these questions but are cautious to provide answers because COVID-19 is still a difficult enemy with its long incubation period; high infection rate; and uncertain but probably distant horizon from either a cure or effective vaccine. In short, the period when the world and Australia will need to live with containment measures that cut back economic activity is still indeterminate but looks like extending several more months at least.
Governments and central banks have taken actions to cushion the effects on households and businesses as COVID-19 containment fosters recession. Many Governments and central banks, including the Australian Government and the RBA, are conducting massive coordinated stimulus involving big increases in government spending and borrowing, combined with large scale buying of bonds by central banks. Governments and central banks will keep these measures in place at the very least while downward pressure related to COVID-19 containment is being experienced by businesses and households.
Even then, there is likely to be a lag, possibly of several months, between the reduction and ending of COVID-19 restrictions and the basing of economic activity – stabilisation of income and spending in the economy. There is also likely be a further lag before information flows to the Government and the RBA that the economy has stabilised. That time when information points to post-COVID-19 economic stabilisation would seem to be the earliest point that the Government and RBA might start to consider winding back “temporary” stimulus measures. This wind back phase is unlikely to be quick and may run to months or years beyond.
The phase of “temporary” coordinated Government and central stimulus aimed at cushioning COVID-19 containment measures will inevitably out-live those containment measures by many months if not years.
Looking ahead to a time beyond the medical crisis is complicated by the fact that it is hard to be confident about how long the crisis, with its restrictions, will last. However, it is possible to be confident that the substantial policy change involving a big lift in government spending and borrowing in conjunction with accommodating monetary policy will last well beyond the medical crisis and associated restriction period.
One indication of this extended period of policy stimulus came from the RBA after its policy meeting last week with a reassurance that the 0.25% official cash rate would not be lifted until it could be confident that the economy had recovered sufficiently to lift annual inflation inside 2% to 3% range. In our view it may be another 18 months at least before the Reserve Bank can have that confidence that inflation is lifting back inside target range.
In the meantime, the RBA through its commitment to buy bonds to ensure that the three-year bond yield stays below 0.25% will be starting to monetise burgeoning government debt. The longer this debt monetisation lasts, the greater the likelihood that it will end what has been more than 30 years of disinflation.
In the near-term, however, disinflation/deflation is likely to have a final and pronounced swansong. The global and Australian economies are starting to experience deep recession caused by COVID-19 containment. The sharp demand shock is causing many prices to stagnate or fall. Several policy initiatives in Australia – reducing health care costs; child-care costs; rental costs – will add to downward pressure on prices. Energy costs are also falling as collapsing global demand outstrips the efforts of OPEC to reduce oil supply, including the latest commitment to cut oil supply by 10%.
Not all prices are falling. Some basic grocery items are rising in price due to shortages, and in some cases associated profiteering, but these examples are few compared to the many items in the CPI basket of goods and services that have been affected by large cuts in demand or policy measures capping or cutting prices.
Beyond COVID-19 restrictions, whenever that is, the beginnings of recovery in household and government spending will coincide with high government spending and the RBA continuing to monetise government debt. The lift in prices could be pronounced as demand lifts. The base effect of low CPI increases through the COVID-19 containment period could emphasize the acceleration of annual inflation through the early post-containment phase.
There will undoubtedly be many economic changes beyond the period of COVID-19 containment. One that is in the making comes directly from the massive change from budget deficit containment to large-scale coordinated fiscal and monetary stimulus. This policy change is a very powerful antidote to the longstanding phase of disinflation. While in the near-term COVID-19 restrictions provide added impetus to disinflation, once those restrictions are lifted inflation is likely to build.