Financial narratives often arise in the dark, unexpectedly penetrate the markets and then spread like viruses there.

They displace existing narratives and mutate.

This development, which the Nobel Prize winner Robert Shiller described in his book "Narrative Economics", is currently running through the story of inflation.

For a long time, the narrative of deflation dominated events in the markets.

The recession would reduce the utilization of overall economic capacity, which should depress the price level.

The central banks internalized this narrative and fought the supposed deflation risk with zero and negative interest rates.

But as we know from George Soros, financial markets are "reflexive".

They change just by trying to influence them.

As a result, the more the central banks fought deflation, the weaker the narrative became.

Eventually the inflation narrative penetrated the markets and began to compete with the deflation narrative.


This is likely to have been due to the fact that capacity bottlenecks and delivery problems caused the prices of raw materials to rise and the increase in indirect taxes in countries like Germany raised all prices.

But these price impulses alone would probably not have been enough for the rise of the inflation story.

Then there was the oversized stimulus package from the new US administration under President Joe Biden.

Together, these developments caused the inflation narrative to go viral and to supplant the deflation narrative.

Interest rate hikes could herald the next financial crisis

The battle of narratives creates a dilemma for central banks.

If you hold on to the narrative of deflation and interest rates remain low, even though this is being replaced by the inflation narrative, you will lose your credibility as the guardian of price stability.


If, on the other hand, they follow the inflation story and increase interest rates, over-indebted states, companies and private households threaten to go bankrupt and the next financial crisis is imminent.

Presumably the central banks will try to get out of this dilemma by fighting the inflation narrative propagandistically.

Some elements from their arsenal for combating the deflation narrative are already visible.

Downside risks for the economy continue to be emphasized and an increase in inflation, even above the inflation target of around two percent, is assessed downwards as compensation for past target failures.

With the promise to keep central bank interest rates low for a very long time and to continue buying bonds for just as long, an attempt is being made to counter the rise in market interest rates for bonds with longer maturities.


Should these appeals fail, the Federal Reserve and the European Central Bank are likely to follow the example of the Bank of Japan and limit the rise in the yield curve from short to long bond maturities through targeted market intervention.

It will not even be necessary to name return limits like the Bank of Japan, as the message can also be conveyed through clever interventions.

The financial markets should be happy.

If interest rates stay low, the prices of stocks, real estate and other real assets will continue to rise and the prices of bonds will be spared, even if inflation rises.

But no wild party without a hangover afterwards: Confidence in the purchasing power of money will wane.

Thomas Mayer is founding director of the Flossbach von Storch Research Institute and professor at the University of Witten / Herdecke

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