Two years after the onset of the pandemic, inflation has become one of the main concerns for the global economy. We have record price rises in Europe and the United States which could be addressed with monetary policy measures. In Latin America central banks have been taking rapid and decisive action since last year, raising interest rates. But what is actually happening with global inflation? In this article we explain the reasons for the inflationary pressures and what we can expect to happen this year and in 2023.
The world appears to be moving towards a stage of acceleration in inflation not seen in the last forty years. In the US inflation reached 7% year-on-year in December, the biggest increase since 1982. In the eurozone inflation reached 5.1% in January, the highest level since the advent of harmonised statistics in 1997.
In Latin America the history of inflation is different, but here we have also seen an acceleration since the start of 2021. Starting from rates in a range of 3-4% in Brazil, Mexico and Chile, we have moved towards rates of 10% in the former and 7% in the latter two countries.
What is inflation?
Inflation is a general increase in prices that reduces people’s buying power and erodes their ability to purchase or save.
When we take a detailled look at the drivers of inflation in the various regions, there are clear signs of the presence of so-called "supply inflation", stemming from increases in energy prices and bottlenecks in global supply chains, largely related to the ceasing of activities during periods of lockdown in many countries and, subsequently, the recovery of the economy.
Good or bad news?
The fact that global inflation has a supply component on this occasion is, it could be said, good news. But, paradoxically, it is also bad news. Let us proceed step by step.
Why is it good news? Because as was the case in the famous Oil Price Crisis in the mid 70 (perhaps the most significant global supply inflation event, which enabled economists to become familiar with the phenomenon of "stagflation"), as soon as the events that give rise to the disruption are dealt with, prices tend to return to their previous levels.
The bad news is that it is unclear how long these disruptions to global supply chains will last because this depends on many factors including the possibility of further outbreaks of COVID-19, for example.
Mechanisms for controlling inflation
Perhaps the most challenging aspect of supply inflation is that its "cure" is not very straightforward. In the event of demand inflation it is necessary to cool economic activity through monetary policy, for example, by raising interest rates. Supply inflation, on the other hand, presents a dilemma that tends to leave those responsible for economic policy in a real quandary: if they take measures to rein in aggregate demand and tackle inflation, they could put the economy at risk of going into recession - and in this instance the risk would be of weakening the global economy.
And to complicate matters still further, at times an inflationary process can start on the supply side, but if it continues over time, propagation mechanisms are generated. These are the so-called second-round effects resulting from wage negotiations adjusted to this higher level of prices and the widening of business margins that attempt to pass on the increase in intermediate costs to final prices.
Inflation is expected to ease slightly this year and more noticeably in 2023 as the supply factors that caused the surge disappear. But in the meantime, we do not know to what extent central banks will have to redirect inflation. Acting in time to tackle inflation avoids greater evils, but doing so early is also costly. Finding the perfect moment is where the art of being a central banker lies.