With the tepid recovery from the 2008 global financial crisis still fresh in mind, policymakers around the world have embraced fiscal and monetary policies as aggressive and accommodative as we’ve seen since World War II. Base effects will no doubt dissipate, and an inflation scare that we expect to play out in coming months will likely ease. But the threat of persistent higher inflation is real.
We're watching for the extent to which any ramp-up in U.S. fiscal spending beyond the $1.9 trillion American Rescue Plan Act (ARPA), enacted in March, may influence inflation psychology. Our enhanced inflation model—the subject of forthcoming Vanguard research—investigates, among other things, the degree to which inflation expectations can drive actual inflation.
That inflation expectations could have a self-fulfilling nature shouldn't come as a surprise. As individuals and businesses expect to pay higher prices, they expect to be paid more themselves, through increased wages and price hikes on goods and services.
Fears of a self-perpetuating wage-price spiral are understandable, given the experience of older investors with runaway inflation in the 1970s. But many of the factors that have limited inflation, notably technology and globalization, remain in force. And we expect central banks that will welcome a degree of inflation after a decade of ultra-low interest rates will also remain vigilant about its potentially harmful effects.