The Global High Inflation Equilibrium

Before COVID, inflation was chronically low across all of the G10 - now it's the opposite

In the decade after the global financial crisis, inflation was chronically low across all advanced economies. That caused a lot of head scratching and - in many ways - set the stage for massive fiscal stimulus during the pandemic. After all, if inflation was always going to be low, interest rates were going to be low also, encouraging the illusion that governments had lots of fiscal space to do stimulus.

That’s turned out to be wrong. Now that post-COVID supply shocks have faded, inflation has settled well above target across all advanced economies. As the chart above shows, core CPI inflation has transitioned to a higher steady state in the US (blue), the UK (black), Japan (red) and the Euro zone (orange). There’s obviously lots of idiosyncratic drivers in each place, like the energy shock in Europe after Russia’s invasion of Ukraine or the AI revolution in the US that’s driving electricity demand higher. But all these idiosyncratic stories can’t explain the global shift up in inflation. That has to be about monetary policy and global activity that’s running hot.

The chart above averages inflation in the pre-COVID equilibrium (2016 - 2019) and compares that to the average pace of inflation since the start of 2024, once supply shock effects from the pandemic had faded. Even Japan, which had been flirting with deflation before the pandemic, is now seeing much higher inflation. The story is similar in the Euro zone, which also had very low inflation pre-COVID and now has core inflation well above target. Idiosyncratic stories don’t explain this broad rise in inflation. Instead, a more likely explanation is that monetary policy on a global level is too loose and the world’s economy is running hot. In a way, the low-inflation period before COVID sowed the seeds for its own demise. If global monetary policy was too tight before the pandemic, it’s too loose now.

All this takes us back to the “debasement trade.” While it’s true that inflation break-evens are still well behaved, silver just hit a new high yesterday, as the purple line in the chart above shows. Fear of debt monetization is elevated and the high inflation equilibrium we’ve transitioned into is a key reason for that.