23 January 2022

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Inflation, pandemics, and wars

Author: Luigi Campopiano

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In economic terms, the fight against Covid has been compared to a war: national resources have been requisitioned to face the "invisible enemy," raising public debt levels around the world. Goldman Sachs used data dating back to the Black Death in 1300 to compare how inflation and government bond yields behaved in the aftermath of the 12 largest wars and pandemics in the world. The result of the research is clear: inflation increased significantly during and in the aftermath of the great wars, while it remained weak during and after the pandemics. Same dynamics for bond yields.

According to Goldman Sachs, the contrast in inflation/yield trends during wars and pandemics has two reasons: 1. In wars, public expenditure is used to finance increased expenditure related to armaments. In pandemics, any increase in public expenditure is used to bridge the gap left by the lack of private sector demand; 2. Wars are often associated with the widespread destruction of physical capital, which increases investment demand and pushes interest rates higher. Pandemics do not involve any loss of physical capital (only human lives). Here are some examples of wars and pandemics:

• World War I: Inflation accelerated sharply as a result of rapid economic growth fueled by military expansion before the conflict, and since from 1914 onwards, the UK, Germany, and France were forced to abandon the Gold Standard (50% on an annual basis in Germany, 25% in the UK and 17% in the USA);

• Spanish flu: it is estimated to have killed around 40-50 million people worldwide, reduced real GDP per capita by an average of 6%, and had a "negligible" impact on the price level;

• Napoleonic war: the UK government tripled public spending within 5 years, the price level increased by 59% in the following 3 years (also due to the suspension of convertibility with gold) and then subsequently stabilized;

• The Black Death: the bubonic plague led to a 30-45% reduction in the English population. The economic effects following the sharp reduction in labor were a doubling of real wages and a significant reduction in the rates of return on land, but no price hikes will occur.