• Home
  • About
  • 151 IMPACT AWARDS
  • Subscribe
  • Conference
  • Events Calendar
  • Webcast151
  • MOTB
  • Log In
  • Register

Room 151

Impact Awards –>
  • Treasury
  • Technical
  • Funding
  • Resources
  • LGPS
  • Development
  • 151 News
  • Blogs
    • David Green
    • Agent 151
    • Dan Bates
    • Richard Harbord
    • Stephen Sheen
    • James Bevan
    • Steve Bishop
    • Cllr John Clancy
    • David Crum
    • Graham Liddell
    • Ian O’Donnell
    • Jackie Shute
  • Interviews

Why should LGPS be concerned about rising inflation?

0
  • by Guest
  • in Blogs · LGPSi
  • — 8 Apr, 2021

Photo by Hakan Nural on Unsplash

The impact of the coronavirus pandemic, lockdown and wider economic uncertainty created  deflationary pressures which raise important considerations for the Local Government Pension Scheme writes Daniel Booth.

Since Paul Volcker chaired the US Federal Reserve in the 1980s, we have been experiencing a disinflationary cycle. The impact of the coronavirus pandemic, lockdown and the wider economic uncertainty has created further deflationary pressure, with a rising output gap accompanied by growing unemployment.

This has been combined with longer-term deflationary trends, caused by excessive developed world debt, low levels of labour market bargaining power (due to automation and offshoring) and weak levels of productivity growth.

Authorities internationally have responded to the dire economic situation induced by Covid-19 with a combined economic expansionary response, which may prove to be a critical turning point in the disinflationary cycle.



Stimulation

The extent of both monetary and fiscal stimulation has been larger, faster, and broader than that which followed the 2008 global financial crisis. The monetary stimulus implemented in 2020 saw the balance sheet of the Fed increase significantly with additions including corporate and high yield debt to support credit markets.

Meanwhile, the European Central Bank, alongside other central banks, engaged in rapid quantitative easing programs. The 2020 fiscal stimulus has been extensive and equivalent to four percent of global GDP (versus 1.6% during the 2008 crisis), with government budget deficits reaching the highest levels since the Second World War.

Major differences between the 2020 Covid crisis and 2008 global financial crisis are the impacts on incomes, debt levels and commercial banks.

Commercial banks entered 2008 with excessive leverage multiples (30:1) and minimal capital ratios. Since then, the banks have deleveraged and built up their tier-one capital ratios—a key measure of a bank’s financial strength—so that they reached the current crisis in a healthy position. Consequently, there was little need to offset a reduction in lending. In fact, the opposite has happened, and lending increased. In addition, household incomes have been maintained by government fiscal programs and cash levels have substantially increased.



The quantitative easing we are witnessing currently is a coordinated monetary and fiscal stimulus, with the Treasury borrowing money created by the central bank (‘deficit monetization’).

Rather than ending up as extra central bank reserves this is having a more direct impact on money supply which is expanding at double digit rates. The combination of loose monetary and fiscal policy combined with stable commercial banks and high household and corporate cash levels sets the background for a shift in the inflationary environment.

Also contributing to an inflationary environment is Federal Reserve’s has adoption of an “inflation averaging” target, meaning that to offset any prior inflation shortfall, they will now need to overshoot their inflation target to raise the average.

The Fed recently noted that it would keep rates flat until they have achieved full employment and inflation exceeds their 2% target—so they may be on hold for an extended period.

Although central banks cannot lower nominal rates much further due to the zero-bound interest rate, they can lower real rates by increasing inflation and inflation expectations. After 1945, the Fed purchased bonds to keep yields lower than 2-2.5% to keep deficit funding affordable, whilst experiencing 5.5% average inflation (-3% real rate).

This enabled economies to manage down debt burdens after the war. Global debt levels are elevated again, so higher future inflation would help reduce the future real debt burden (see graph below).

Inflation risk

The LGPS should consider the longer-term inflation risk may be under-priced by markets due to the underlying market conditions beginning to change. As discussed above, we are seeing renewed quantitative easing without the offsetting effect of commercial bank deleveraging.

Another factor for the LGPS to ponder is whether we may see a reduction in global supply-side efficiency as we enter a period of de-globalisation (regionalisation) with changing corporate supply chain preferences (onshoring).

This will increase trade frictions and costs, and Brexit in the UK may raise unit labour costs. A study of history also informs us that debt deflations typically turn inflationary, following the path of least resistance, and behaviours may change as participants recognise the new debt perception.

When thinking about impacts on inflation LGPS should note that throughout the coronavirus crisis, households have retained cash levels despite rising unemployment.



Bridgewater estimates current developed world household cash balances are equal to 12.5% of GDP, five times the normal level. It is typical for cash balances to increase during a recession, but the magnitude of the pandemic cash build-up is unique, and any future liquidation of excess cash holdings could act as an additional stimulus.

The authorities are likely to want to stimulate economies further by lowering real interest rates, and with nominal interest rates at the lower 0% bound, they can do this by increasing inflation and inflation expectations.

The Fed’s move to an inflation averaging regime is a clear indication of this direction. In 2021 growth and inflation outlooks are likely to appear higher set against 2020’s low-base impact, combined with ongoing policy stimulation and elevated levels of cash and credit creation as outlined above.

It is clear we’ll see a pick-up in near-term inflation levels, partly due to low base effects from the second quarter of 2020, and it is likely that central banks will tell us this is transitory.

For the LGPS the more important consideration will be the longer-term inflation outcome which will reflect the balance between the impact of the inflationary policies, described above, alongside the residual deflationary forces, such as automation. The LGPS with long-dated inflation linked liabilities should be mindful of the longer-term, inflation risks that has the potential to impact both their assets and their liabilities.

Daniel Booth is chief investment officer at Border to Coast.

Photo by Hakan Nural on Unsplash

AWARDS INFORMATION

Read about the awards here.

Read about the seven categories here.

For submissions click here.

To read case studies of finance team impact, click here.

————————————-

FREE monthly newsletters
Subscribe to Room151 Newsletters

Room151 Linkedin Community
Join here

Monthly Online Treasury Briefing
Sign up here with a .gov.uk email address

Room151 Webinars
Visit the Room151 channel

Share

You may also like...

  • LGPS Q&A – David Walker of Hymans Robertson on the triennial valuation LGPS Q&A – David Walker of Hymans Robertson on the triennial valuation 30 Jan, 2019
  • The ECB and Euroland The ECB and Euroland 4 Feb, 2012
  • And here is the LGPS news: It’s better than you read in the press And here is the LGPS news: It’s better than you read in the press 26 Feb, 2020
  • David Green: IFRS 9, treasury management and the accounting David Green: IFRS 9, treasury management and the accounting 29 Jan, 2018

Leave a Reply Cancel reply

You must be logged in to post a comment.

  • Register to become a Room151 user

  • Latest tweets

    Room151 1 hour ago

    Impact Awards: Liverpool’s cafe culture and Warrington’s investment in homes: The CCLA/Room151 Impact Awards showcase  finance teams with a direct impact on their local communities and the environment. This week we spotlight Liverpool City Council’s… dlvr.it/RxJsKb pic.twitter.com/dEYpaz6HP0

    Room151 4 hours ago

    Doing something in #localgov #finance for housing or regeneration? Check out the 'Place Shaping' category room151.co.uk/impact-awards/… sponsored by @31tenConsulting in the CCLA/Room151 Impact Awards. #timetoenter !! pic.twitter.com/dU99vE6Wws

    Room151 23 hours ago

    Doing something in #localgov #finance for Adult Social Care & Health? Check out the ASC&H category room151.co.uk/impact-awards/… sponsored by Fundamentum Social Housing REIT in the CCLA/Room151 Impact Awards. #timetoenter !!

    Room151 23 hours ago

    Doing something in #localgov #finance for the environment? Check out the 'carbon management' category room151.co.uk/impact-awards/… sponsored by @ACSLLP in the CCLA/Room151 Impact Awards. #timetoenter !!

    Room151 23 hours ago

    So what are the seven categories for the CCLA/Room151 Impact Awards? Here they are room151.co.uk/impact-awards/… #localgov #finance #outcomes

    Room151 1 day ago

    Why should LGPS be concerned about rising inflation?: The impact of the coronavirus pandemic, lockdown and wider economic uncertainty created  deflationary pressures which raise important considerations for the Local Government Pension Scheme writes… dlvr.it/RxF7Fs pic.twitter.com/JlcjROBIpz

    Room151 2 days ago

    JOB ALERT: LPFA Finance Director vacancy: London Pensions Fund Authority Finance Director and s151 Officer Competitive salary and benefits The largest Local Government Pension (LGPS) provider in London with around £6.5 billion of assets and 135[...] dlvr.it/RxBdJP

    Room151 2 days ago

    Richard Harbord: Further signs that local government finance is failing: The crisis in Liverpool and a fix for education budgets are further indication that local government finance is in need of a root and branch review. Even for those students[...] dlvr.it/Rx9PSV pic.twitter.com/sAanC2gEyu

    Room151 1 week ago

    Impact Awards: Finance helps launch school meals company and support business during lockdown: The CCLA/Room151 Impact Awards will showcase the way finance teams have a direct impact on their local communities and the environment. This week we spotlight… dlvr.it/RwnlF4 pic.twitter.com/AJhne1MVG4

    Room151 1 week ago

    "This work has made a vital, practical contribution to ensuring people have been supported through the pandemic." #impact #151awards #covid #s151 room151.co.uk/treasury/impac… #impactcasestudies #councilfinancemakesadifference

    Room151 1 week ago

    room151.co.uk/impact-awards/ #passiton #localgov #s151 #151awards pic.twitter.com/A0uO0dwBkM

    Room151 1 week ago

    Financial pressures loom for 2023 and beyond: Kate Ogden writes the government has addressed most of the short-term Covid-19 financial pressures facing English councils, but problems loom in 2022-23 and the years following. As we enter the[...] dlvr.it/RwfDsz pic.twitter.com/hpv2R09w75

    Room151 2 weeks ago

    Calling all #localgov finance officers and #s151s room151.co.uk/impact-awards/ It's the #151Awards Thanks to the @LGALocalism for helping us get the word out along with all the LA treasury societies. pic.twitter.com/Nkal9BrH1J

  • Categories

    • 151 News
    • Agent 151
    • Blogs
    • Chris Buss
    • Cllr John Clancy
    • Dan Bates
    • David Crum
    • David Green
    • Development
    • Forum
    • Funding
    • Graham Liddell
    • Ian O'Donnell
    • Interviews
    • Jackie Shute
    • James Bevan
    • Jobs
    • LGPSi
    • Mark Finnegan
    • Recent Posts
    • Resources
    • Richard Harbord
    • Stephen Fitzgerald
    • Stephen Sheen
    • Steve Bishop
    • Technical
    • Treasury
    • Uncategorized
  • Archives

    • 2021
    • 2020
    • 2019
    • 2018
    • 2017
    • 2016
    • 2015
    • 2014
    • 2013
    • 2012
    • 2011
  • Previous story JOB ALERT: LPFA Finance Director vacancy
  • Next story Impact Awards: Liverpool’s cafe culture and Warrington’s investment in homes

© Copyright 2021 Room 151. Typegrid Theme by WPBandit.

We use cookies to ensure that we give you the best experience on our website. If you continue without changing your settings, we'll assume that you are happy to receive all cookies from this website.OK