Coronavirus has hurried Western economies towards a situation of ‘inflate or die’. However, it is very difficult to get inflation off the ground. High debt, international competition, the introduction of modern technology and the tendency to save more are factors that slow down economic growth and inflation. Governments and central banks will have to work closely together in order to achieve inflation.

In any case, central banks will have to keep (real) interest rates very low and they will have to continue to create vast amounts of excess money in order to boost asset prices as far as possible. In addition, governments should ensure that borrowing activity is stepped up. They should borrow more themselves or issue guarantees that enable the private sector to borrow more.

Following the outbreak of the credit crunch, central banks in the West never managed to boost demand – read: debt – to the extent where inflation ended up at distinctly higher levels. Banks are dripping with money, but relatively little of it is used to step up credit supply. Debts are simply too high and growth prospects are too low – certainly considering the outbreak of COVID-19 – for companies and consumers to step up borrowings to finance investments and consumption. However, it is also not an option for policy makers to leave the situation as it is. This would lead to deflation and therefore an economic crisis. The only remaining option is to allow the government to borrow far more, financed by the central bank. This indirectly comes down to helicopter money. In other words, the government doles out money to the masses. This policy can be kept up until inflation rises too much. However, two factors need to be considered here:

• In theory, it is possible that households that receive money from the government save this money rather than spend it. This is currently evident as, following the outbreak of the coronavirus, many private individuals and companies concluded that they had far too few reserves to absorb setbacks. This makes them save more now, also because a second wave is quite likely.
• Public deficits and debts cannot be raised indefinitely. At some point, the debts and deficits will reach levels where no-one believes that the old debts will ever be repaid by the government. This, in turn, triggers chaos in the financial system. This should therefore be avoided.

The latter is an issue in the current situation due to the following reasons:

• Public finances are bound to deteriorate substantially in the future due to ageing populations.
• The corona crisis has forced the government to intervene in unprecedented ways in order to prevent an economic disaster.
• At this point, consumer savings are still high, and this forces the government to take additional measures to boost the demand side of the economy sufficiently.

Obviously, these problems will become more acute if the assumption is that the corona crisis will last even longer. This is why high hopes have been placed on a vaccine. However, we are somewhat cautious here, as experts tell us that they would be happy if the vaccine turned out to be 50%-70% effective. In addition, about a third of the Western population has indicated holding off on a vaccine for the time being. The relevant individuals are concerned about unwanted side effects of the vaccine. This means that we are likely to face many problems with the coronavirus in the years to come – to the extent where they push down economic growth – albeit to a lesser extent than this year. This means that, for the time being, the private sector is unlikely to focus on dissaving to any great extent.

Chart 1: Given the risk of a second wave consumers will likely keep the savings rate elevated

Source: Refinitiv Datastream/ECR Research

In line with this, we believe that, for the time being, the private sector will reduce debt as far as possible, rather than the other way around. It would therefore not surprise us if public deficits have to stay at very high levels for a long time. This will probably be at the expense of ongoing confidence in public finances. This is why we see more and more Western governments turning to a last resort: a policy where the government guarantees debts run up by companies and individuals. This will suddenly make it attractive/possible for the private sector to borrow more money. At the same time, this will not increase the public deficit, as guarantees are not included in it. This would only happen if the government had to pay out in connection with a guarantee.

Outlook interest rates

At this point, the Fed seems to indicate, using forward guidance, that it will keep interest rates low for a long time. It will also continue to support the economy by buying up bonds, via massive money creation. The central bank will only switch to negative interest rates and/or yield curve control (a policy aiming to place a ceiling on government bond yields) in emergencies. Fed policy will continue to be geared towards boosting inflation, and this is why long-term interest rates will gradually come under more upward pressure. The same developments will be evident in Europe, but to a lesser extent.

Chart 2: Aging of US population means even more trouble for the government budget in the future

Source: Refinitiv Datastream/ECR Research

However, it remains to be seen what long-term interest rates will do if economic growth slows down again before too long due to the flare-up of the coronavirus. In this case, long-term interest rates could decline slightly for a while. Incidentally, we believe that both Europe and the US will leave short-term interest rates unchanged.

In the longer-term, we expect the authorities will increasingly pursue an inflationary policy to alleviate the debt burden. This mainly applies to the US, and this is why we believe that the dollar will become a structurally weak currency in the long run (massive deficits in public finances and current account deficits, so-called twin deficits). This will also drive prices of shares and gold to far higher levels.