As I wrote in my last 2 posts, “Central Banks vs Bond Markets” and “Biden’s Stimulus Plan, Inflation, and Interest Rates”, there is a realistic risk of inflation and an interest rate shock for 2023, with potentially serious consequences for all markets and the real economy, and perhaps also politics. Lets explore 3 possible scenarios, with numbers.
Although inflation “predictions” are notoriously wrong and generally simply based on a slow-moving “auto-regressive process” (i.e. that inflation is most explained by past inflation), still, assumptions are what make the difference between scenarios. Other than past inflation, here are the variables that matter in building scenarios about how much inflation and how severe of an interest rate shock could be coming:
The “fiscal multiplier” over a 24 month period (more on this later).
Personal savings and spending behaviour by households.
Estimated potential GDP, which goes hand-in-hand with the estimation of the output gap.
Velocity of money.