The Banking Executive Magazine - August 2021

step back and reconsider what is meant by inflation and its opposite, deflation. Not all inflations or defla- tions are similar. Price declines (de- flation) driven by technical improvements can be good, as in the case of electrical motors or chemical dyes in the late nineteenth century, or of computers (and many other electronic consumer goods) over the past 50 years. These are not the sort of price changes that lead to Great Depression-style defaults and debt crises. The same distinction applies to infla- tion. There can be “good” price in- creases, as in cases where markets need a signal to produce a certain re- sponse. The current surge in the price of computer chips reflects a shortage of supply, which in turn is curtailing production of automobiles, refrigerators, and other products that rely on these components. But “Chipageddon” is not the end of the world. Rather, it is giving chip pro- ducers a clear signal to ramp up pro- duction and increase supply. Here, price increases are serving a useful role, and we can expect that chip prices will come down in the future. Or consider a scenario where a dif- ferent market response is required. Today’s rapid recovery has increased the demand for freight transportation, pushing up fuel and energy prices. Moreover, a shortage of truck drivers have left gas stations empty. But these scarcities are the result of tem- porary glitches. They do not augur a repeat of the 1970s oil shock. What higher gasoline prices will do is signal to consumers that "it pays to reduce one's fuel consumption and dependence on fossil fuels". That message aligns nicely with a wider recognition that the economy ur- gently needs to shift away from car- bon-intensive energy sources. Again, we should allow prices to perform their proper function of guiding con- sumers’ behavior and future con- sumption plans. These contemporary phenomena do not represent the kind of inflation that would justify pumping the brakes on the recovery. Higher chip and fuel prices simply reflect what producers and consumers need to do. As an impressively efficient plan- ning instrument, the price signal is not an indicator that should be sup- pressed, just as febrile patients should not be told to put their ther- mometers in the refrigerator. The high temperature reading provides necessary information for recovering one’s health. Historically, major accelerations of globalization have often been ac- companied by inflationary surges, each of which has led politicians and consumers to cast around for cul- prits. In the 1850s-60s, rising prices were interpreted as a response to gold discoveries or financial innova- tion following the development of new types of banking. In the 1970s, US monetary policy bore much of the blame, though some also pointed to financial innovation (a surge of in- ternational bank lending) and the role of producer-country cartels. But the fact is that in both cases, price effects helped to trigger behav- ioral changes that eventually brought efficiency gains and lower prices (“good deflation”). Hence, it might be helpful to think of contemporary price increases as examples of “good inflation,” insofar as they represent the first step in a useful and benefi- cial process. Such a change in mindset would re- quire a departure from the consensus of the 1990s and 2000s, when infla- tion targeting became central banks’ key weapon in the quest for price sta- bility. Around the world, govern- ments and central banks reached a common view that a 2% – or per- haps 2.5% – rate of inflation (based on an index of consumer prices) was desirable. Accordingly, they started to worry whenever the rate moved even a few decimal points below (or above) that line, usually based on past horror stories about bad defla- tion (the Great Depression) or bad in- flation (as in the aftermath of the twentieth century’s world wars). This monetary-policy consensus was appropriate for a stable world in which there had been no radical shocks for many years. One of its key advocates, Bank of England Gover- nor Mervyn King, described the era well when he coined the acronym NICE (Non-Inflationary Continuing Expansion). ISSUE 152 AUGUST 2021 the BANKING EXECUTIVE 35