Is a surge in inflation a significant threat to sustained recovery? The likely answer is: no. But the proposition is no longer absurd, as it was when Kevin Warsh, then a governor of the Federal Reserve and now a candidate for chairman, stated in March 2010 that “I don’t think we should be complacent about inflation risk”. That misjudgment should rule out his candidacy.
Yet times have changed. This explains the Fed’s commitment to gradual monetary tightening. The European Central Bank is planning to withdraw stimulus. The question is whether this tightening cycle will be smooth or bumpy. Inflation would make the difference.
Even a broken clock will be right twice a day. Austrian economists and goldbugs have warned of an imminent upsurge in inflation for years. Maybe they will be right, at last. The consequences would be highly disruptive. If inflation rose really rapidly, monetary policy would have to tighten significantly. That would trigger fears of a recession. Moreover, even if long-term real interest rates did not rise, risk premia on inflation, expected future short-term interest rates and the uncertainty surrounding those expected future rates would all jump, raising yields on conventional bonds substantially.