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The Problem with the Reflation Narrative

 7 min read / 

Since the global financial crisis of 2008, the world has been on the edge of its seat for any signs of inflation promised by the large stimulus injected by world governments, quantitative easing programs of central banks and a return to consumption at pre-crisis levels.

Until 2016, the world economy had been unable to return to the same levels of growth and inflation, and the consensus had formed that we are now in a low-growth environment. However, the unanticipated outcomes of geopolitical events in 2016 have had a significant impact on the future expectation of the economy.

These events have created a new narrative which delineates that the world will experience strong reflation in the years to come. Trump’s administration has religiously promised pro-business regulation shifts, including the tax cuts coveted by corporates, and has pledged to stimulate the economy through infrastructure spending.

The pound has experienced substantial devaluation after Brexit, leading to a rise in consumer prices. The European economies are steadily recovering, with the favourable election outcomes in countries such as Italy and France spurring confidence into the economies, and debt-burdened countries such as Greece and Italy are attempting to reduce their bank’s bad loans and tighten regulations.

This, coupled with Japan’s improving fundamentals and a positive outlook for growth in the rest of the economies, has led people to believe that inflation is imminent. However, the key fundamental obstacles for inflation have not improved or changed, and the aforementioned narrative is likely to be a short-lived one.

Debt Deleveraging

Debt deleveraging is deflationary as it directs spending away from consumption and investments towards repaying debt and interest. The crisis has left countries saddled with massive amounts of debt – global debt has grown by $57trn since 2007.

Amongst the developed economies, none have been able to decrease their debt-to-GDP ratio since 2007. These debt figures comprise of government, corporate and household debt, indicating that the entire global economy, buoyed by low interest rates, has relied primarily on borrowing to maintain its spending.

Global sovereign debt is slated to reach $44trn this year, out of which an estimated $25trn of new debt has been a result of the crisis. The deleveraging of this massive amount of debt by sovereign governments would imply that either strong GDP growth or a reduction in the fiscal budget is impending, with the latter being more likely owing to the low-growth environment.

Ignoring Trump’s bold claims to miraculously reduce the deficit while cutting taxes and increasing infrastructure spending, economists agree that countries will have to reduce debt burdens by reducing their budget or, minimally, balancing deficits.

Household debt-to-income ratios have also been rapidly increasing in countries such as Australia, Canada, Denmark and Sweden, resulting in a decrease in household savings. Unless the increase in household debt is tapered off through government initiatives and there are active measures in place to increase savings, it will translate to lower consumption and investment when debt payments are due.

Technological Advances

Technological disruptions such as cloud computing, blockchain technology, artificial intelligence and fintech have attracted increasing attention and are viewed as the ideas that will shape our future. Their common goals are reducing costs and eliminating the need for third parties, along with maintenance requirements. A marked example would be the recent inflow of capital into driverless vehicle technology – a technology whose widespread use would render millions of drivers jobless.

Their common goals are reducing costs and eliminating the need for third parties, along with maintenance requirements. A marked example would be the recent inflow of capital into driverless vehicle technology – a technology whose widespread use would render millions of drivers jobless.

An increase in workers looking for jobs due to redundancies from technological advances would lead to an oversupplied labour market, reducing wages, and consequently, consumption. This increase in retrenchment, along with the cost reductions technology has consistently delivered from its inception, makes a strong case for deflation.

Income Inequality

Income inequality, especially in developing countries, has been on a steady uptick since the crisis, with many arguing that it is a result of policies undertaken by the government which have disproportionally benefitted the rich.

An example typically quoted is the loose monetary policies espoused by central banks which, coupled with uncertainty in the global economy, have resulted in asset inflation rather than business expansion.

These assets are owned primarily by the wealthy, contributing to an increase in income inequality. In addition to this, outsourcing by corporations whose sole motive is profit and cheap labour in China and other developing countries are also explanations for the increase in income inequality in developed countries.

Rising income inequality can have adverse effects on the economy and prices as the wealthy tend to save and invest more of their income as opposed to lower class workers, resulting in a decrease in consumption.

Furthermore, the consumption patterns of the wealthy are skewed toward luxury imports and overseas investments whereas the poor tend to focus consumption on locally-produced necessities, and investments into small-scale businesses, both of which have proven to be more beneficial for the health of the economy by increasing consumption levels.

Decline in Population Growth

As the chart above clearly displays, world population growth is on a steady downtrend due to the loss of baby boomers’ momentum in the 1970s, policies such as one-child policy in China and households having smaller families as a result of urbanisation.

Note that while the population is still increasing, it is the population growth that matters for growth and inflation. A decreasing growth rate has less pressure on the entire chain of production as infants and young individuals do not contribute to the labour force but contribute to the consumption in an economy until they enter the labour force. Economists such as Ruchir Sharma have cited declining population growth as the chief reason behind our low growth and inflation environment.

Preventive Measures

These factors are prevalent in the majority of the developed and developing world and will not be surmounted without systemic changes to consumer attitudes and a directional change in government policies.

To achieve this, a government must reduce its debt burden through reducing its deficit as well as that of its households through more flexible mortgage contracts, tighter lending standards and macro-prudential rules. The workforce should be equipped with skills to remain relevant in the dynamic technological environment and companies should be explicitly transparent about measures to preserve talent in the event of automation.

Income inequality can be improved through more redistributive tax systems, improved social mobility for the minority classes and well-designed labour market policies that provide workers with sufficient wages. A decline in population growth can be offset through attracting skilled immigrants, though resistance from populace and challenges in integration are huge obstacles for this.


Although the policies proposed are challenging to accomplish with the excessive bureaucracy present in existing government structure and the political backlash they may create, it is a step in the right direction. The preventive measures listed are in no measure exhaustive and governments will have alternate tools and policies to combat these issues.

However, the focus of the world is not on these serious issues as we are captivated in the current bull market with all-time highs in stock indices portraying the increasing expectation of growth and inflation in the future. The higher we project the economy to grow without addressing these key issues, the further it will eventually fall.

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