The surge in inflation in recent months has served as a harsh lesson in humility to experts whose specialty is supposed to predict what the economy has in store for us in the future. Maybe new tools will help them do better. But maybe also some events cannot be predicted.
Aoutche! In yet another upward revision to its forecasts, the Bank of Canada — the great guardian of low and stable inflation in the country — predicted, in April, that inflation would still be well above its target. 2% at this time of year, to an average of 5.8% for the whole of the second quarter. In April, inflation rose to 6.8%. And in May, it was 7.7%, we learned on Wednesday.
We now have to see the June figure to gauge the extent of what will inevitably prove to be “the biggest failure so far in a period of systematic underestimation of inflation”, have estimated in a brief analysis by economists Warren Lovely and Taylor Schleich of the National Bank. In all honesty, admitted their colleagues from the Mouvement Desjardins, Royce Mendes and Tiago Figueiredo, in front of Wednesday’s data, “we expected price increases stronger than what consensus forecasts [du secteur privé] estimated, but these figures are still very surprising”.
lesson in humility
It’s “a lesson in humility,” Bank of Canada Deputy Governor Toni Gravelle admitted last month, faced with this repeated underestimation of inflation by his institution. But if it is any consolation, it is not alone, the other major central banks and international economic institutions, as well as the chorus of private sector experts have not done better, recently found a study by the Bank Central European.
Yes, of course, some dissenting voices were heard. The most often quoted are those of former US Treasury Secretary Larry Summers or former chief economist of the International Monetary Fund Olivier Blanchard, who both warned, more than a year ago, against a surge of inflation. “It didn’t come from where I thought it was in the end”, however, the famous French economist was forced to admit himself last month in the FinancialTimes.
If the great experts are generally not too wrong in their economic forecasts in normal times, this is not the first time that they have been thwarted in times of crisis. During the last financial crisis, they had also systematically underestimated the seriousness of the financial and economic collapse that would follow the fiasco of the subprime in the United States and were then too optimistic about the strength of the recovery, it was admitted a few years later. Conversely, the damage that the COVID-19 pandemic would inflict, particularly on world trade, was greatly overestimated, two IMF experts noted last month.
A changing world
Why do central banks and other economists have such difficulty today in predicting the path of inflation and in influencing its course? It is that this crisis is not like the others, had pleaded Toni Gravelle. The shock inflicted by the opening and closing of economies to curb the pandemic felt more like the impact of a huge natural disaster than a normal recession. And who could have predicted the explosion in demand for goods and houses outside the major centers that would follow? Not to mention Russia’s invasion of Ukraine, China’s almost complete shutdown recently, and bouts of drought.
Another problem, observed last week the wall street journalis that economists’ models have mainly been developed to explain and predict the evolution of consumer and business demand.
However, the current surge in inflation comes very much from the other side of the equation, that is to say from the ability to meet this demand through an (often global) supply of goods, food and sufficient fossil energy.
Much like with the financial sector before the last crisis, it was also assumed that the globalization of value chains would naturally lead to a better distribution of risk and to their better resilience, explained last fall the Nobel Prize winner in economics Michael Spence. in the Project Syndicate analytics website. In fact, decentralized and complex, “the system is essentially myopic and discovers blockages when they arise”.
And then, our conception of the role of public authorities is lagging behind, noted in April The Economist. The lesson learned from the last crisis was that governments and central banks had ended their economic stimulus measures too quickly for fear of deficits and inflation. If we had known better how to take advantage of low interest rates and the population’s confidence in the ability of central banks to bring inflation back to their targets, the recovery would have been less slow and painful.
This time, more and more voices are being raised to accuse governments of having done too much and central banks of having waited too long. Clearly in catch-up, the latter are today raising their interest rates in an accelerated manner to curb demand from households and businesses, while repeating that the bulk of inflation is outside their zone of influence. because it is the result of global phenomena such as oil and food prices, disruptions in value chains and the war in Ukraine.
The experts and us
The forecasts of experts and the behavior of the financial markets show that they generally share the analysis of the situation of the central banks and are still confident in their effectiveness of action, noted The Economist in another article last week.
All that remains is to see if consumers and businesses have the same point of view. Until now generally well anchored around the target of central banks, their expectations in terms of inflation in the medium and long term are particularly important.
Because beyond the merits of each other’s economic models, if we come to anticipate an increase in prices and wages which would remain higher than what we have known for more than 20 years , this will not fail to change the reality that we seek to understand and influence. Next portrait of the situation in this area in Canada, July 4.