Inflation up, but will come down in 2022

Inflation figures continue to occupy the minds. Early last year, when US inflation rose from about 1,5% in January and February to about 2,5% in March, I thought that US inflation could eventually rise further to as much as 5% . I didn't dare say that out loud or write it down. If an economist produces predictions that the reader considers totally unrealistic, then readers stop taking him seriously. In December, US inflation rose to 7,0% and Dutch inflation to 5,7%.

I have been saying for some time that inflation will be higher and more persistent than the central banks say. And I stick to that. Inflation will certainly fall in 2022, but not as much as central bankers think. They assume that the wage increase will not be too bad, that the logistical disturbances in the world will disappear and that prices that have risen due to shortages will also fall and that energy prices will fall. Well, of course you can. If all this happens at once, inflation will fall rapidly. But maybe that's not all happening at the same time.

I think wage increases in the US are already clearly accelerating. This is not the case with us, or less so. I dare not say anything about the energy prices. If they fall significantly, inflation will fall very quickly. Logistical disruptions will gradually diminish. The question is whether the lower costs that this may entail for producers will quickly be passed on to consumers. I do not think so. Inflation will indeed fall, but that will not happen very quickly.

Rent, rent, rent
In the US there is another issue. Nearly 31,1% of the inflation basket (CPI) is determined by rents, ie actual rents (7,6%) and imputed rents (23,5%). Rents make up almost 40% of so-called core inflation. The housing market in the US works quite well. When there is scarcity, prices rise. If house prices rise (faster), more will be built, but rents will also rise (faster). The graph shows the relationship between house prices and rents imputed to homeowners. This relationship is by no means a one-to-one relationship, but in general rents follow house prices with some delay. Judging by this chart, it seems likely that rent growth will continue and accelerate. Due to the high weight of rents in the inflation basket, this will complicate a rapid decline in inflation to 2%.

What will/should the Fed do?
It is clear that the Fed is going to stop the asset-buying program, raise interest rates this year and also begin to shorten its balance sheet. While I'm less optimistic about inflation than the Fed, I don't think monetary policy needs to be tightened significantly nor that the Fed will. The emergency measures must disappear and interest rates must rise slightly. But inflation expectations remain limited, so the Fed can take a look at how far and how fast inflation will come down on its own. In addition, no one wants financial instability that can easily arise in the face of rapid, aggressive monetary tightening. Finally, I recall 2019. The Fed had been raising interest rates very gradually since late 2015. In 2019, the official interest rate in the US had reached 2,5%. The economy actually couldn't stand that and within a few months the Fed was forced to cut interest rates again by a full percentage point. That must have been a traumatic experience for the Fed that will still be remembered. Caution will therefore be the trump card.

For a change: a riddle
My eye fell on some remarkable differences between the Dutch and the American inflation statistics. In December, electricity rates in the Netherlands were 103,8% higher than a year earlier. In the US it was 6,3%. The gas price in the Netherlands was 66,5% higher than in December 2020, in the US 24,1%. Nobody expects that the price development of this kind of business will be the same in both countries. But these differences are very large. Rarara, where do they come from?

CPB calculation of the coalition agreement is devastating
We already knew that the new government allows itself quite a bit of financial leeway. And the new administrative culture apparently means that not everything is boarded up in a coalition agreement. That is why a calculation by the CPB at the presentation of the coalition agreement was undesirable.

In the end it came about at the request of the House of Representatives. You cannot expect the CPB's accountants to aim for an open confrontation with the new government. Every word in the report will be carefully considered and weighed up. An employee who makes critical remarks about the coalition agreement will undoubtedly be put to the test internally. Like: "Are your calculations correct? Do them again. And then again. How sensitive are your calculations to the assumptions? Have a colleague check your calculations carefully and have another colleague check the calculations again redo." That's how it goes, of course. Criticism of a coalition agreement certainly does not happen overnight and in the report the CPB will try to present any criticism in veiled terms. The report that eventually came to the table was not a lie. My conclusion is that the CPB is scathing about the coalition agreement. These things struck me:

1. Health expenditure will continue to rise rapidly if policy remains unchanged. The new government is taking a number of measures to reverse this increase. The CPB reports that in the view of the CPB these measures are not sufficient to realize the desired changes. So sample 'rich math'.
2. According to the coalition agreement, some expenditure that the government intends to make is incidental. The CPB is of the opinion that this is not the case in all cases and that some of that expenditure is structural. This will of course affect the development of public finances in the longer term.
3. According to the CPB, the government will not succeed in making all planned expenditures in the current term of office because of labor shortages. So air castles.
4. Under the proposed policy, public finances will deteriorate. In the short term, the deterioration is of course not too bad. According to the CPB, the budget deficit will be 2025% of GDP in 2,7, against 0,7% of GDP under unchanged policies. But the government debt projection in 2060 will rise from 28% of GDP under unchanged policies to 92% (!) under proposed policies. I've never seen anything like it. Incidentally, this calculation is based on the current interest rate structure. If interest rates rise, the numbers will get worse in the future. The CPB therefore concludes that the new government is passing on the bill for the intended policy to future generations.

This will be debated in the House of Representatives next week. That is promising.

Nitrogen crisis is a fabrication
Now, of course, I am not free from a philosophical conviction. I too have an opinion about the proposed policy. In my view, the nitrogen crisis is a fabrication. We're going to spend billions on that and let our children and grandchildren pay for the costs. The EU is at the forefront of the world in climate policy. Why should we be more ambitious than what the EU asks of us, which puts us at the forefront of the world? My personal belief is that climate alarmism is unnecessary and inappropriate and that proposed climate policies will be largely ineffective anyway.

The most disturbing thing is that the bill is largely passed on to the future. In one of his short columns in the FD, Mathijs Bouman argues that people want this policy, but do not want to pay for it and that the bill must therefore be shifted to the future. I'm different. If I want something, I'm willing to pay for it. I suspect that is the case for most. If the voter does not want to pay for this policy, it seems to me a more logical conclusion that they do not want it at all.

Interesting experiment: Humiliating people from Groningen to the bone
Much has already been said about it, so what more can I add? Nothing really, but I just need to get it out there. On the day that the new ministers and state secretaries were sworn in and stood festively on the steps with the king, thousands of Groningen residents stood in a long line online or physically in the freezing cold. And while everyone who qualified was sworn in in The Hague, many Groningen residents were less fortunate and many fished behind the net. Who the hell would come up with something like that? And what was the message here?

There are only two possible explanations. The first is that the government just wanted to make a statement, like 'We are not to be trifled with. Those who cause problems don't end well." Of course, for maximum effect, that statement had to be made on the day the government crew let themselves be hoisted onto the comfortable plush. Unfortunately we don't have a million Uyghurs that we can put in re-education camps as a warning to the rest of the population, but fortunately we do have a lot of Groningers. First, we stole the natural resources of the people of Groningen for decades and gave nothing in return. Then their houses subsided and torn, after which we have been stringing them along for years by promising compensation but not paying it. And now it was apparently time to humiliate those sympathetic Groningers to the bone. Throw them a grab that isn't nearly enough and then let's see what happens when they have to wait in long lines. It looks like a sickening psychology experiment. Incidentally, the Groningers did not seem to be at one and a half meters. Were they lucky that there were no boas around. They were, of course, in line.

A second possible explanation is that no malicious intent was involved. The logical conclusion that you can draw from this alternative explanation is that the debacle was only caused by boundless incompetence, a bastard disinterest in the well-being of the people of Groningen and a glaring lack of empathy. So not so much going on. Apparently business as usual…

Oh yes, and then also announce in passing that we are going to pump more gas again due to a delivery obligation to Germany. That amount of gas may have no influence at all on earthquakes, but it must have felt like a whole bag of salt in their wounds for the people of Groningen. Or are they too tired for that now?

It is not acceptable for citizens to stand with burning torches at the homes of politicians, but if I were a Groninger…

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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