There are sure signs of economic recovery in the US, EU, China, and India as well. But it may be too early to call it a full-fledged recovery. The macro variables reflect a rebound in economic activity, but the level of economic activity is still not at the pre-pandemic levels as yet. This is mainly due to the fact that there is still a partial lockdown, and till the time it is not lifted the return to full normalcy would remain more or less elusive. It is pertinent to note that some of the European countries have recently gone into a more stringent lockdown with the objective of controlling the spread of the second wave as also the new strain of the infection. Therefore, what ultimately matters is the speed at which the pandemic is controlled and the efficacy with which vaccination is taken to a larger section of the vulnerable population. Till the time this is not achieved, we may not be able to be confident that the initial gains in recovery will be sustained.
One of the crucial factors which has been sustaining the economies is the expansion of liquidity by central banks. This liquidity is what is supporting the financial markets as also the economic recovery. But is there any reason why the liquidity may come down and if so when? That would be a possibility if retail inflation raises its head and would require the central banks to curtail liquidity over a period of time. Forecasts of higher inflation in the US is already prevalent, and the same is true of some of the emerging markets too.
One thing that may result in higher inflation is the depreciation of the US Dollar against the major currencies. The depreciation of the Dollar could also be an indication of changing investor preferences with investors gradually moving into assets abroad like emerging markets. The depreciation in currency at a time when monetary policy is soft may fuel inflationary pressures, though this will have a moderating effect on the current account deficit. In case of price level pressures, the Fed policy could suddenly take a change of course, though at this juncture it does not seem so, as US inflation is well below the target average inflation rate of 2.00 per cent. Employment or job market conditions are not improving as expected and this may act as a dampener. An inflation rate above the average inflation rate is forecast for the next year, while for this year it is likely to be a shade below the target rate as per some reliable forecasts.
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