Inflation has suddenly become a major problem in almost all the countries around the world. What is unusual this time is that advanced economies are at the fore, with annual consumer price inflation currently at 8.5% in the US, 7.5% in the Eurozone and 7% in the UK. In emerging markets and developing countries, traditionally more resilient Asian economies are also recording higher levels of inflation, with price increases in India, Bangladesh and South Korea reaching 7%, 6.2% and 4.1%, respectively, in March.
In some cases, skyrocketing inflation has country-specific causes. For example, in Turkey, President Recep Tayyip Erdoan is trying to run the central bank himself. In Sri Lanka, the complete mismanagement of foreign exchange reserves and agricultural policy is to blame.
In general, however, inflation is one of the least understood phenomena within economics. We still have enough knowledge to prevent the types of major hyperinflationary episodes seen in the past, such as the record-breaking cases in Germany in 1923 and Hungary in 1946, and more recently in parts of Latin America and Africa.
But now striving for a systematic management of inflation is one area where economics is weakest. The study of money in general equilibrium was abandoned because it is too difficult to model mathematically, and we continue to pay a price for it. Much of the talk of experts on inflation management sounds professional, but is like the twitter of the birds. A non-expert voice will sound unpleasant, but chatter can be meaningless in the same way.
All we can do at this stage is to carefully use the knowledge we have about inflation. In addition, better global coordination of monetary policy is essential. These minimum steps are especially important for emerging economies in Africa, Asia and Latin America, where inflation can push large vulnerable populations into extreme poverty.
With US inflation not reaching levels since 1981, the US Federal Reserve is coming to blame for a lot more. I believe the criticism is overblown. For starters, contrary to what some observers claim, the primary driver of current inflation is not demand, but supply, and in particular the bottlenecks and supply-chain disruptions initially triggered by the COVID pandemic and exacerbated by the ongoing war in Ukraine. Done.
When inflation is purely due to excess liquidity and demand, price increases in goods and services are more uniform. But today, food and energy account for a disproportionate share of the headline inflation figure in most places. If we remove these items, Eurozone inflation falls sharply from 7.5% to 3.2%, while US inflation falls from 8.5% to 6.5%.
The difference in core inflation between the US and the eurozone suggests that aggregate demand, even if not the primary cause of today’s price pressures, played a large role in the US. Besides, the increase in demand happened for a good reason. US President Joe Biden’s administration implemented one of the largest government spending packages in US history, with a $1.9 trillion US rescue plan totaling about 25% of gross domestic product (GDP) to support the more vulnerable sections of society. The pandemic is part of the impetus. During the covid crisis. Although inflation is high, poor Americans are better protected than they otherwise would have been.
In the case of emerging economies with large vulnerable populations, it is worth bearing in mind that when a country experiences predominantly demand-driven inflation and prices rise across the board, exchange rate corrections are large within its borders. may limit the scale effect. If the prices of all goods and services in one country increase by x% and the currency depreciates by x%, there is little spillover to other countries. But today’s inflation is disproportionately skewed across goods and services, and rising prices cannot be confined to a country by exchange-rate correction alone. Spillover effects are inevitable and are happening now.
Another reason why central banks appear to be relatively ineffective in tackling today’s inflation is the progress of globalization. It is understood from the 17th century, when the Riksbank in Sweden (1668) and the Bank of England (1694) were among the world’s first central banks, that an economy should not have more than one money-creating authority. All major economies of the time soon established central banks according to this principle.
This system is now being challenged unexpectedly. As globalization progresses (despite recent supply-chain disruptions), and goods, services, and capital flow from country to country more easily than ever before, the world is increasingly becoming a single economy. has been But currently there are more than 150 central banks in the world. We are returning to a situation that the policy makers of the 17th century tried to remedy.
And that means trouble for inflation management. If a country tries to contain inflation by raising interest rates, money will flow into that country, raising its exchange rate and reducing exports. Thus not every country will naturally be as enthusiastic about monetary tightening as they all collectively would like.
As is true in many other areas of public policy, addressing this collective-action problem requires better global coordination. As the world’s largest economy and issuer of its main reserve currency, the US dollar, the US will need to take greater responsibility for this effort. ©2022/Project Syndicate
Kaushik Basu is a former Chief Economist of the World Bank, former Chief Economic Advisor to the Government of India and Professor of Economics at Cornell University.