The annual inflation rate in the US reached 8.4 % in March 2022, the highest in four decades. Latin America shudders at the memory of how Governments controlled inflation then. Are there conditions for a new Volcker shock? What is different four decades later?
Since the late 2020s, the world began to experience a sustained rise in inflation that has not stopped. As the outbreak of the COVID-19 pandemic began to subside, the world experienced a sustained increase in price levels that has not stopped. The Russian military operation on Ukrainian territory has become a further force pushing up prices globally. While several commodity-exporting countries see rising commodity prices as an opportunity to improve their external economic balances, they will also have to face the pressure that prices will put on them.
“If your only tool is a hammer, every problem looks like a nail”. Still haunted by the clever preaching of monetarist guru Milton Friedman’s ghost, all too many monetary authorities address every inflationary threat or sign they see by raising interest rates.
Friedman’s dictum that “inflation is always and everywhere a monetary phenomenon” still defines the orthodoxy. Despite changed circumstances in the world today, for Friedmanites, inflation must be curbed by monetary tightening, especially interest rate hikes.
As 2022 progresses, the economic growth/stock markets/inflation control trilemma that we have already discussed becomes more evident. Now we start to look at central banks' decisions and analyse how these will impact growth and financial markets.
Recent statements by Christine Lagarde, President of the European Central Bank (ECB), say that post-confinement inflation remains outside their influence. Its sources are the recovery of demand and border upheavals, she says. The ECB, like the Fed, combats the economic effects of the pandemic with large injections of liquidity into the markets and improvements in financial conditions. However, the latest monetary policy statement left aside price stabilisation, its only mandate. Does this mean that the ECB will sit back and watch inflation decimate purchasing power?
Globally, inflation closed 2021 at its highest level in the last twenty years (40 years in the case of the US) and projections indicate that during 2022. However, even if it is lower than last year, we will continue to see it high in 2022. Why is it a top concern for governments, central banks and consumers?
Governments are concerned that central banks will speed up the normalization of interest rates in the face of high inflation rates. This would put a brake on economic recovery and job creation and, in some cases, would cause the deterioration of the fiscal balances of some countries that acquired debt to mitigate the effects of the economic contraction or slowdown.
The strategies followed by governments and central banks to control inflation will determine the economic conditions of the coming years and the ability of the world to recover from the economic contraction of 2020.
The rebound of the world economy was the great feature of the year 2021. Anticipated as strong rebounds, they were less strong for some than for others. Governments that injected money into public investment improved their recovery more than those that did not.
2021 has been the one with the highest inflation in the world since the 1970s with Brazil, Turkey and the United States leading the way, but followed by everyone else. The consequence is that central banks around the world initiated interest rate hikes as a way to contain inflation, so the GDP growth rate in 2022 will be very low overall.
It was a good year of economic rebound, but at the cost of high global inflation that central banks will have to face in the years to come. The recovery was rapid due to increases in government deficits and debt, and even so, spending still does not contribute to economic growth.
Since economic activity resumed after the lockdowns, high rates of inflation have been observed around the world, although some monetary authorities have indicated that it is transitory. . The integration of global value chains, the magnitude of international trade and the productive and financial interdependence have shaped this post-confinement inflation.
Inflation is far from transitory, companies are facing a combination of supply chain challenges, as well as higher costs for energy, raw materials, packaging and shipping, all while becoming one of the biggest concerns of consumers around the world.
Central banks have taken a more aggressive stance. US Fed officials accepted that high inflation, which has risen to 5 percent, will be long-lasting. These measures are contractive, contrary to the much desired recovery of the product.
With the onset of the COVID19 pandemic and the application of the first measures of social isolation and the closure of non-essential economic activities, the financial market collapsed and the commodities market began a new cycle of price contraction.
The recovery of commodity prices has had two moments. The first was marked by strong injections of liquidity into the markets and low interest rates. The second moment occurred when the upward trend extended beyond the recovery of previous levels throughout 2021.
The effect of rising commodity prices has been a combination of multiple factors. Its behavior, although presented as a short-term trend, may induce inflationary processes in the long term.
Global inflation is rising rapidly in a year of uneven growth rates, higher than estimated in the US and the European Union (EU), and lower for all but the Asian economies.
The question is why inflation is being discussed when consumer price indices in the US and EU are stable, and what effect these discussions have on international interest rates.
To counteract the inflations produced by these causes, central banks are preparing to readjust interest rates, which are currently at their lowest real levels in decades.