Mike Dolan

LONDON (Reuters – The battle for stable prices is at risk as the long-dormant inflation narratives and memory reawaken. It adds a complex psychological aspect to the task beyond simply tightening monetary policing.

Many economists believe that high inflation is not a matter of excess money, contrary to strict monetarists’ assertions. Instead, it depends on changing popular narratives, which in turn entrench expectations, and alter the behavior of households and businesses.

This change in behavior – whether it be in wage negotiation, price setting at work or government indexation of expenditure – fuels and embeds inflation’s rise over time. This is what central banks fear the most: the “de-anchoring” of expectations.

Monitoring the news headlines is a useful tool because it helps to determine the dominant narrative.

The speed at which the narrative can shift in this world of rapid-fire media and ubiquitous media is far faster than it was when inflation was high, almost four decades ago.

It would have been about the money supply. You could have expected that central bank money printing and near zero interest rate for the past decade had had more effect than the small flicker in core inflation rates. Yet, all of that money ended up in financial assets – not chasing higher consumer prices or wages.

However, the dial has been shifted for the first-time in many decades by a sudden jolt caused by the pandemic and the recent shock to the energy prices.

Pascal Blanque (Amundi Institute Chairman) has spent years studying the effect of changing media narratives on investment models. This analysis supports his conviction that we will be “back to 1970s high inflation regime.”

He believes these changes could occur suddenly or exponentially. Short-term memories link spiking inflation rates over the last year with long-term memory of inflationary eras past. It’s already taking place and it is likely that the central banks will not be able stop it.

“Narratives have a part in spreading inflation exponentially, like a viral infection, and turning it into an epidemic with feedback loops. Self-fulfilling prophecies.” He added that artificial intelligence allows us more to understand them.

He said that people form expectations the same way they forget and remember. This refers to what he calls a “coefficient” of forgetfulness that increases the farther you are from shocks or episodes, but can also change abruptly, and media acts as a reminder and an ‘accelerator”.

Amundi chart on GDELT news searches https://fingfx.thomsonreuters.com/gfx/mkt/gdvzyamnkpw/One.PNG

ASR chart on inflation in earnings calls https://fingfx.thomsonreuters.com/gfx/mkt/akvezyonjpr/Two.PNG

Headline inflation over 50 years https://fingfx.thomsonreuters.com/gfx/mkt/egpbkeolxvq/Six.PNG

COEFFICIENT IN FORGETFULNESS

Blanque and her team used GDELT (or the Global Database of Events Language and Tone) to track this newsflow. They clearly revealed that daily inflation ‘identifiers’ increased by more than twofold over the past 12 months and exceeded the peak COVID equivalent of March 2020.

Furthermore, these search results showed that the rankings of ‘Roaring 20s,’ ‘Back to the 70s,’ and ‘Geopolitical risk’ outperformed competing narratives like’secular stability’. These were the dominant themes in the period following the 2008 banking crisis.

Others who monitor news sentiment are able to find similar results. According to Absolute Strategy Research, their global inflation newsflow track is very compatible with the 10-year inflation expectation in bond markets. It is also at its best in at least 20 years.

ASR points out that ASR has seen a rise in inflation mentions in earnings calls to corporate companies – this is the highest level in at least twenty years, and three times more than the number of calls falling into this category at the beginning of the year.

This is a far cry from the monthly inflation forecasts and consumer surveys that show a more equivocal reading of market-based inflation expectancies.

Inflation-expectations captured by ‘breakevens’ from the inflation-protected 10-year U.S. Treasury bond briefly topped 3% last week for the first time in 25 years before slipping back.

Inflation expectations for households at the University of Michigan is higher than 5% over a one-year period according to their survey. This is however below core inflation, and the 5-year outlook for core inflation falls to 3%.

They are still far below the inflation rates of 10% and more in 1970s.

Blanque believes Amundi is just beginning to see the impact of this shift on the public narrative, and that a US inflation of 4-5 percent was more likely over the coming years.

According to him, central banks have deliberately been ‘behind inflation’ and will continue doing so even if they tighten their policy in the future. This could help avoid recession.

They and their governments may be seduced by higher inflation as it generates higher output growth, nominal wages and increases in debt.

He said that the biggest victim may be “great monetary consensus” between central banks, which he calls a compromise of various approaches and a crisis orthodoxy.

University of Michigan consumer inflation survey https://fingfx.thomsonreuters.com/gfx/mkt/byvrjnqxnve/Three.PNG

Markets’ inflation expectations https://fingfx.thomsonreuters.com/gfx/mkt/lgvdwgoxbpo/Five.PNG

G4 central bank balance sheets https://fingfx.thomsonreuters.com/gfx/mkt/lbvgnylwdpq/Four.PNG

Similar columns

COLUMN – Using the “magic money tree” as central banks call it time:Mike Dolan

COLUMN-Wage-price spiral alarm risks prolonging real income funk: McGeever

The author serves as editor-at–large at Reuters News for markets and finance. These views are entirely his.

(by Mike Dolan. Twitter (NYSE::): @reutersMikeD. Editing by Chizu Nomiyama