Economists ‘Push Back’ on Arguments for Higher Inflation

Arguments for strong inflation don’t pass the “smell test,” according to a Bank of America research note.

Alex Kraus/Bloomberg

Alex Kraus/Bloomberg

Bank of America economists don’t buy that higher inflation is coming.

“We push back against the latest arguments for higher inflation in the developed markets world,” Bank of America’s global economists said in a research note Friday. “Despite the rise in inflation breakevens and inflation expectations in consumer surveys,” they said that “real people on the ground are expecting low wages and low pricing power.”

And while home prices may be rising, the economists see “a weak link” with rent inflation partly because of the sharp drop in mortgage rates in almost all developed economies. Additionally, the Covid-19 crisis has disproportionately hurt lower-paid service workers who tend to be renters while prompting many people to leave cities for markets with greater home ownership, according to the note.

Home prices and rents “are likely to move in [an] opposite direction today, particularly in the U.S.,” the economists wrote. That runs counter to inflation arguments under “asset price theory,” which suggests strong price correlations between home prices and rental streams.

Another argument for higher inflation assumes a “convex Phillips Curve,” according to the note. “That means that as demand surges in some sectors and fades in others, prices tend to rise sharply in the high demand sectors but don’t fall all that much in the weak demand sectors,” the Bank of America economists explained.

“We don’t buy the argument that shifts in demand across sectors means that some prices surge while others stay flat,” they wrote. “There is plenty of evidence that prices can move dramatically in both directions.”

For example, prices have spiked for meat, fruit and vegetables, and used cars and trucks, while collapsing for energy prices and airfares, according to the note. Also, with wage growth tending to “bunch around zero” in bad times, the economists asserted that they don’t understand why the case wouldn’t be the same for prices.

[II Deep Dive: Inflation Never Materialized After the Last Crisis. JPMorgan Thinks This Time Is Different.]

Canada is the only developed economy in which Bank of America economists forecast inflation of more than two percent next year, according to the note.

“Stepping back, we would suggest the following smell test for arguments for strong inflation,” they said. “After a decade of futile efforts to raise inflation back to target, after two years of escalating trade tariffs and after the biggest recession in the post-war period, rising inflation is a concern. Really?”