Balancing act: economic growth, inflation and productivity growth

Published: Jul 2021

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Following decades of downward pressure on inflation (due to ageing populations, productivity growth and globalisation), central banks have had to step up monetary stimulus to an ever-greater extent. Growth has become increasingly dependent on high asset prices, while the latter have become increasingly reliant on low interest rates and money creation by central banks. This means that a considerable decline in asset prices would substantially slow down growth, raise concerns about high debt and increase deflation risks. This is why the priority of central banks is to keep asset prices high.

Another priority of the Fed is to guarantee the stability of the financial system. This is increasingly under threat due to exceedingly high valuations of many assets, speculative behaviour in cryptocurrency markets, so-called meme stocks and SPACs and a considerable increase in the use of leverage. These developments historically point to market bubbles. This is particularly risky now, as authorities have few remaining resources to stimulate the economy. Also, other drawbacks – like increased inequality – of ultra-loose monetary policies are becoming more evident.

For now, central banks opt to accept the risks of market bubbles and mainly focus on achieving higher inflation. It remains to be seen what will happen if they succeed and consumer price inflation (expectations) start(s) rising. We believe that the latter will happen in the longer-term, as result of deglobalisation, more credit supply to households and companies, persistent high public deficits and continuing ultra-loose monetary policies.

In this scenario, central banks cannot keep up their ultra-loose monetary policies, as inflation (expectations) would rise to even higher levels, and long-term interest rates would ultimately rise rapidly, which could trigger market chaos.

The most favourable scenario for financial markets is one in which inflation stays low. This would allow central banks to keep boosting asset prices. However, increasing inequality and market bubbles would become even more problematic. These drawbacks do not necessarily have to occur (or they would be minor) if productivity growth is accelerated.

The most unfavourable scenario is one in which inflation (expectations) and long-term interest rates rise, while growth stagnates at the same time.

This is why it is currently crucial for the financial markets to know whether and how fast inflation will rise, and how central banks will react to this.

But it will be difficult to get a good sense of the underlying economic strength and inflationary pressures. Data over the past and coming months have been and will be strongly influenced by base effects and start-up problems as many economies are being reopened. As for the longer-term, we can say the following about economic growth, inflation and productivity growth.


Many economists think most economies will recover quickly from the corona crisis, partly because governments and central banks have implemented massive economic stimulus. It is therefore quite likely that consumers will largely go back to normal before long. In addition, economic growth in the quarters ahead is set to benefit considerably from consumer dissavings and increased corporate investment. Companies will want to invest more because demand is likely to pick up, because they will catch up on investment plans that were paused in the last year, and to reinforce supply chains. Government support and public deficits will decline considerably in this case, which is negative for growth. However, this will be offset by higher job growth. After 2022, economic growth will end up at far lower levels due to fading catch-up demand and fewer catch-up investments, as a result of which growth will tend towards potential.

At this point, potential growth is under downward pressure in many countries due to ageing populations and less immigration. The level of potential growth will ultimately depend on productivity growth.


US productivity has been rising for a number of years, and there are a number of developments that point to more upward pressure on productivity growth, not just in the US, but elsewhere too:

  • Companies are investing more in technology and intellectual property; these are elements that experts say are necessary to boost productivity in the service sector.
  • Technological changes have accelerated in recent years. The corona crisis could be the shock that drives large-scale adoption of technological breakthroughs.
  • Companies should anticipate higher wage costs and lower availability of personnel due to ageing populations, the commitment of governments to increase employee wages in real terms and the risk of deglobalisation. This increases pressure to invest more in labour-saving measures and/or to boost efficiency.

However, another potential scenario is one in which productivity growth does not end up at structurally higher levels:

  • Deglobalisation comes down to less foreign competition, which removes the pressure to step up efficiency.
  • Governments want to make up an ever-larger part of the economy. There is a risk that they use the additional expenditure for elements that do not or barely increase productivity (but which are socially desirable, for example). Another risk is that the government raises corporate taxes, as a result of which companies want to, or have to, reduce the amount they spend on investment.
  • The number of zombie companies has increased. This impedes the process of creative destruction which ensures that more efficient companies remain.
  • Many people with low-paid jobs have been laid off in the corona crisis. This has boosted productivity. Productivity growth will slow down as the economy is being unlocked and many low-wage jobs are reinstated.

On balance, the most likely scenario is one in which US productivity growth temporarily declines, after which it will pick up. However, it is unlikely to return to current levels. Productivity in Europe could increase somewhat, but Europe will lag behind the US. This is because Europe has many zombie companies and its economy is generally less dynamic than the US economy.


Inflation is evident now, but this mainly concerns asset inflation. Structurally higher inflation based on the consumer price index (CPI) requires more surplus money to flow to the real economy, as opposed to it staying in the financial sector. This is likely to happen in the coming years:

  • Far more emphasis on the pursuit of loose fiscal policies in order to boost economic growth. Combined with more credit supply to households and companies.
  • A process of deglobalisation and increased protectionism, which will reduce deflationary pressures.
  • Historically very high valuations for equities and bonds, which will make it increasingly difficult for asset prices to rise. In addition, they will become more vulnerable to negative surprises. As a result of which asset markets will attract less money.
  • Inflation also has a major psychological component. The current sentiment among investors is that (almost) all assets are better than holding cash. This is why (almost) all asset prices are rising or have risen considerably. This sentiment seems to gradually spill over to consumers.

We still expect inflation to decline in the shorter term, mainly due to fewer major base effects and the gradual disappearance of bottlenecks. However, in the ensuing period, upward pressure on consumer price inflation is likely to prevail, and the psychological component will become more important. We believe inflation will rise gradually, because productivity growth will increase slightly at the same time, which will resolve bottlenecks and, in turn, will boost supply.

Central banks will then increasingly face a dilemma. On the one hand, they are under pressure to slow down inflation, while, on the other hand, they are concerned that a tighter monetary policy will have too much negative impact on asset prices and economic growth.

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