Weekly Buzz: What you can learn from the past 100 inflation shocks

Of all the factors that have been driving markets over the past few years, one’s arguably been the most important this year: inflation. Previously brushed off as a short-term blip, inflation’s now at levels we haven’t seen in decades.

In a paper by The International Monetary Fund (IMF), they set out to get a grip on potential inflation trajectories, diving deep into the archives to analyse 100 inflation jolts over the last five decades. Here’s what history tells us is likely to happen next.

Lesson 1: Inflation is sticky, even when sparked by a short-lived event

Inflation is often initially lit up by an unexpected event. Problem is, even when that triggering event starts to normalise, the resulting higher inflation doesn’t tend to dissipate.

Looking at the 100 inflation episodes as a whole – even those stemming from different triggers – only 60% were tamed within a five-year span. On average, inflation took 3 years to resolve. To put it bluntly, inflation isn’t usually short-lived, even when it’s sparked by an event that is.

Lesson 2: Сountries that resolved inflation applied strict monetary policies

The IMF examined countries during the 1973 to 1979 oil shocks and found that those that successfully cooled inflation did so via consistent, strict monetary policies. These include raising interest rates aggressively and sustaining them, supporting their currencies, and restricting wage hikes (which can also push up inflation, more on this in our Jargon Buster below).

Lesson 3: Inflation's "false dawns" are common

Around 90% of cases the IMF studied saw significant drops in inflation within three years from the first shock, only for it to pick up pace again later. That said, the IMF did find that the main culprits of these double-whammy spikes were central banks and governments who relaxed their monetary policies too early. A cautionary tale, perhaps.

Lesson 4: Successful countries were left bruised, but always rebounded

More aggressive inflation-fighting policies often bring about immediate economic setbacks, including a slowdown in growth and a rise in unemployment. It’s a difficult situation several countries find themselves in right now.

But looking through the past 100 inflation shocks, the IMF’s paper suggests that short-term discomfort paves the way for long-term stability. While rigorous policies can be a bitter pill to swallow, it’s proven to result in sustained economic health.

What’s the takeaway here?

If history’s any guide, inflation should be sticking around for longer, and central banks should be wary of the dangers of pivoting too early. It’s likely they’ll keep rates higher for longer, and brace for some economic backlash in the short term. After all, a tough stance could be just what’s needed for a robust, long-term economic revival.

History doesn't always repeat itself, but it's probably wise to make sure your portfolio can handle an extended period of inflation. Consider diversifying into defensive assets that hold up if the economy doesn’t. Like our USD Cash Plus portfolios that can be a place to invest in ultra-low-risk US Treasuries and capture the decades-high yield.

This article was written in collaboration with Finimize.

🎓 Jargon Buster: Wage push inflation

A pay raise is always good, right? Well, as with most things in economics, there may be ripple effects. Wage push inflation can occur when wages increase across the board: if businesses are paying out more in wages, they often bump up their prices to cover those costs to maintain profits. This can then lead to a circular effect, where inflated prices now demand higher wages to compensate, and vice versa.

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