Opinion – Solange Srour: After the slowdown, will we return to the world of low interest rates and low inflation?

The overriding theme in recent weeks has been the magnitude of the slowdown in activity needed to bring inflation back to near pre-pandemic levels. However, there are two other relevant questions: are we facing structurally higher interest rates? Will global inflation return to levels close to pre-pandemic levels?

After the 2008/2009 recession, the world went through a long period of low growth and almost no inflationary pressure, which allowed interest rates to reach very low levels – in some cases, negative. The term “secular stagnation”, coined by Alvin Hansen in the 1930s, was revived at the time by Lawrence Summers to refer to an environment of a stagnant economy for a long time.

The explanations for the structural fall in interest rates, without there being any inflationary pressures, were: a) on the one hand, a lower demand for investments (given the decrease in the working age population that demanded less equipment and the technological revolution that demanded less and less investments in physical capital for a given production, also resulting in more efficient and cheaper goods); and b) on the other, an increase in the supply of savings (caused by the aging of the population —the elderly tend to use their accumulated savings— and by social inequality, since wealthier people are more likely to save and make them available in search of high returns ).

Supporters of the theory advocated the use of public investment as a key factor to boost economies and put concerns about the sustainability of public debt in an environment of structurally low interest rates in the background. Until the pandemic, this theory gained many supporters, becoming one of the factors responsible for the extraordinary fiscal and monetary expansionism that followed it.

Now, much of the developed world is experiencing its highest inflation since 1970. After a long time betting on the thesis of a temporary acceleration of inflation caused by rising commodity prices, several central banks not only began the process of raising interest rates as they have already announced that they will likely have to bring them to much more restrictive levels compared to pre-pandemic levels. We are facing the risk of a synchronized recession in the most important economies.

Has the equilibrium interest rate, that is, the one that does not bring inflationary pressures, also gone up? If that is the case, the monetary tightening needed could still be greater than expected. Some arguments in this direction are:

1) increased demand for post-pandemic investment with greater digitization and automation;

2) higher government indebtedness and borrowing requirements (which increases the demand for savings);

3) the increase in the premium demanded to finance public deficits after a period of successive inflationary surprises.

To these factors we can add the questions about the risk of the world being more inflationary than before. Are they:

1) energy prices may even fall due to the global slowdown and a possible return of supply once the war is over, but they will be under pressure for a long time because of a radical change in the world’s energy matrix, which will certainly not be a reversible phenomenon;

2) possibility of the world being less globalized. In addition to the problems arising from the breakdown of production chains during the pandemic, the geopolitical tensions aggravated by the invasion of Ukraine increased the need for the production process to be less dependent on external suppliers, or at least on non-allied countries;

3) despite the openness of economies, labor force participation is still below the pre-pandemic level in several regions. The phenomenon of “great resignation” has come to be known as one in which employees reevaluate their careers and leave their jobs, while companies have a record number of openings, putting pressure on wages and prices.

This whole discussion is not merely academic. In a world of low interest rates and inflation, emerging countries attracted investment and grew a lot, even with not so tidy domestic fundamentals – such as high fiscal and external deficits. In a different world, these countries will have to prioritize correcting their imbalances. In the Brazilian case, without a doubt, the biggest imbalance is the fiscal one, which is quite sensitive to interest rates and GDP growth.