Will Inflation Stay High for Decades? One Influential Economist Says Yes
By Tom Fairless, March 9, 2022, WSJ

Mr. Goodhart outlined his theory in a book, “The Great Demographic Reversal,”
co-written with London-based economist Manoj Pradhan and published in Sept 2020.

He argued that the low inflation since the 90s wasn’t so much the result of astute central-bank policies, but rather the addition of hundreds of millions of inexpensive Chinese and Eastern European workers to the globalized economy, a demographic dividend that pushed down wages and the prices of products they exported to rich countries. Together with new female workers and the large baby-
boomer generation, the labor force supplying advanced economies more than doubled between 1991 and 2018.

Now, he said, the working-age population has started shrinking across
advanced economies for the first time since World War II, and birthrates
have declined as well. China’s working-age population is expected to shrink by almost one-fifth over the next 30 years.

As labor becomes more scarce, he maintained, workers will push for higher wages, in turn driving up prices. At the same time, businesses will manufacture and invest more locally to help offset both labor shortages
and the nationalist and geopolitical pressures curbing globalized supply chains. That will increase production costs and local workers’ bargaining power. Global savings will fall as older people consume more than they produce, spending particularly on healthcare. All that will push up
interest rates, he predicted.

Acute labor shortages in the U.S. and Europe this year already have
pushed up wages. In China, as the workforce shrinks and fewer rural
workers move to cities, labor costs have risen. U.S. manufacturing wages
are now less than four times as much as those in China, compared with over
26 times when China joined the WTO in 2001, according to recent research
by investment firm KKR.

“I take the things Charles says very seriously,” said Isabel Schnabel,
who sits on the European Central Bank’s six-member executive board, in
an interview last month. “Charles wants to alert us that we shouldn’t
take for granted that the world ahead of us is going to look the same
as it did in the recent past.”

Fed Chairman Jerome Powell referenced the book in a speech at the annual gathering of central bankers and other finance experts in Jackson Hole,
last August. He disagreed with the central premise, saying at the time
that high inflation rates would likely prove transitory. More recently,
he has stopped referring to inflation as transitory, and the Fed is
poised for a series of rate increases this year.

In Germany, labor shortages are so acute that the government is seeking
to attract 400,000 skilled foreigners a year. In December 2020, then- Bundesbank President Jens Weidmann cited Mr. Goodhart’s ideas to push against the European Central Bank’s easy-money policies.

In China, where the workforce is expected to shrink by about 100 million
over the next 15 years, senior government officials recently translated
Mr. Goodhart’s book into Mandarin. The book has had a print run of
50,000 copies in China.

Joe Zhang, a former economist at China’s central bank, said he sees
evidence of Goodhart’s thesis in the fact that Chinese companies are currently absorbing higher costs and wages by reducing their profit
margins. He said he expects them to start increasing export prices soon,
and that Chinese companies will need to raise wages further to lure
workers back to factories in coastal cities.

The monthly jobs report reveals key indicators about the labor market
and the overall state of the economy, but it doesn’t show the entire picture. WSJ explains how to read the report, what it shows and what
it doesn’t. Photo illustration: Liz Ornitz

At the European Central Bank’s rate-setting meeting in December,
policy makers discussed whether structural changes such as demographics,
the role of China or challenges to globalization could signal a shift
toward higher inflation that isn’t captured by economic models, echoing
the concerns raised by Mr. Goodhart, according to a person familiar with
the matter. The ECB declined to comment.

The ECB’s chief economist, Philip Lane, said in mid-February that
inflation could remain high even after the pandemic is over, pointing
to changes in the world economy such as the role of China and aging populations. Until recently he had said that inflation would soon fall
back below the ECB’s 2% target.

Goodhart, who in addition to his economics work raises sheep on a farm
in Devon, England, studied economic history at Harvard University. He
joined the Bank of England in the 60s as an expert in monetarism,
which attributes inflation to an excess amount of money in circulation.

He helped shape Bank of England policy in the early 80s as Margaret
Thatcher implemented monetarist ideas to bring down double-digit
inflation. He later joined the bank’s newly created Monetary Policy Committee after Tony Blair’s government made it independent in 1997.
The link between inflation and the amount of money in circulation proved
to be unreliable, and the U.K. later abandoned money-supply targets.

Goodhart’s testimony to New Zealand’s Parliament in 1989 proved critical in that nation’s decision to pioneer inflation targeting, in which the central bank aimed to keep inflation close to an explicit target rate, recalled Donald Brash, the country’s central bank governor at the time.
That policy of inflation targeting has been adopted by major central banks, including the Fed.

In Hong Kong, Goodhart helped to establish a peg to the U.S. dollar in
1983 that ended a currency crisis in the former British colony and has
been in place for almost four decades.

He also warned of a buildup of leverage in advanced economies ahead of
the 2008 global financial crisis, former central bankers recall. He
reminded them to monitor risks to financial stability at a time when
they weren’t focused on such concerns, said Donald Kohn, former vice chairman of the Federal Reserve.

“I can’t think of any U.K. Chancellor of the Exchequer who has not been influenced in some ways by the views developed in advance by Charles
since the ’70s,” said Mr. Buiter, the former Bank of England central banker.

The models that central banks have long used to forecast inflation
appear to have broken down. The idea that inflation is a function of
too much money chasing too few goods has lost favor, as has the idea
that low unemployment drives high inflation.

For 9 years in a row after 2008, the growth and inflation forecasts
for the following year by the IMF and Organization for Economic
Cooperation and Development were too high, said William White, a
former deputy governor of Canada’s central bank who once worked under Goodhart at the Bank of England. “Most thoughtful people would say
something is wrong,” he said.

In 2015, Goodhart was working in London with Morgan Stanley’s economics team, including his co-author Mr. Pradhan, to understand why aggressive central-bank money printing after the 2008 global financial crisis had
failed to drive up inflation.

Goodhart recalled the 70s theories that powerful trade unions helped
drive up wages and inflation. Later, the power of labor diminished
largely because of globalization and competition from China, reducing inflation.

He conjectured that a decline in fertility rates in China and the West
could make labor scarce again, giving workers renewed leverage.

Goodhart’s thesis, presented to a meeting of top central-bank
officials in 2016, posited that far higher inflation and higher
interest rates were in the offing.

It spooked investors, said Pradhan. “At Morgan Stanley, we had to
keep weeks and weeks aside for speaking with clients after the paper
was put out,” he said.

The European Central Bank’s Schnabel said Goodhart’s book was initially met with skepticism. “After a long period of very low inflation, many
did not expect inflation to come back quickly and forcefully,” she said. “Then the unprecedented economic disruption happened, caused by the pandemic, and inflation suddenly returned.”

A central criticism of Goodhart’s thesis is that countries with more retirees and fewer workers, such as Japan, have the opposite problem—
very low inflation rates.

Most economists would expect an aging population to lead people and
firms to invest less, consume less and innovate less, while also
generating a savings glut in government securities, said Adam Posen,
a former Bank of England policy maker who now runs the Peterson
Institute for International Economics.

Goodhart argued that workers likely won’t save enough for their
retirement, and that pensioners consume more than they produce,
especially with healthcare. The dwindling pool of savings, combined
with increased corporate spending to secure supply chains and make up
for a lack of workers, will push up interest rates, he predicted. He
said the Black Death, a 14th century pandemic, triggered a quarter-
century of soaring wages and rampant inflation.

As for Japan, the country is right next door to China, which has
been exporting lower prices to the world for decades, Goodhart said.
And even in Japan, he said, there are some signs that inflation is
starting to rise.

Goodhart predicted that with global debt at record levels and asset
prices elevated, central bankers will struggle to tame inflation
without forcing a deep recession. A golden era for central bankers
is ending, he said, and “life will become a lot harder.”

https://www.wsj.com/articles/inflation-high-forecast-economist-goodhart-cpi-11646837755

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