After more than a decade of struggling to bring inflation up to target, central banks around the world now face the opposite problem. Inflation is back and flared up, particularly in the last one year.
The world seems to be on the cusp of a new inflationary era, driven mostly by soaring global energy, commodity and food prices.
Soaring global energy and food prices mean almost 60% of developed economies now have year-on-year inflation above 5%, the largest share since the late 1980s, while it is over 7% in more than half of the developing world.
The rise in inflation reflects the rapid and goods-intensive economic recovery from the Covid-19-induced recession, bolstered by highly accommodative fiscal and monetary policy, which supply has been unable to fully meet, noted Bank for International Settlements (BIS) general manager Agustin Carstens.
“We should not expect inflationary pressures to ease soon as many of the forces behind high inflation remain in place and new ones are emerging,” Carstens said recently.
There are already signs of increased price spillovers across sectors and between prices and wages, as is common in a high-inflation environment. Moreover, the structural factors keeping inflation low in recent decades may wane as globalisation retreats.
The inflationary paradigm may be changing. Central banks need to adjust to this new environment, not least by raising policy rates to more appropriate levels. The world economy must learn to rely less on expansionary monetary policies.
While major economies like the United States and Britain and swathes of less developed ones are now raising interest rates from all-time lows, a rapid acceleration would be needed if a fundamental paradigm shift took hold.
Carstens pointed to professional forecasts, which now see inflation of over 4.5% in the United States and much of Europe over the next two years, and above 3.5% in many other advanced economies.
The immediate implication, a Reuters’ dispatch noted, would be that policymakers would have to quickly shift their “mindsets” to how to stop inflation running out of control, a problem few have had since the 1970s.
On the rise of global inflation, Carstens says, “This I would say is a result of the confluence of three factors.”
First, a surprisingly strong global rebound in aggregate demand: the global economy is expanding much more quickly than in the post-recession recoveries of recent decades.
Second, a surprisingly persistent rotation in demand towards goods and away from services, particularly customer-facing ones.
And, finally, a surprisingly unresponsive aggregate supply, which has found it hard to keep up with surging demand.
He stressed the forces behind high inflation could persist for some time. New pressures are emerging, not least from labour markets, as workers look to make up for inflation-induced reductions in real income.
The structural factors that have kept inflation low in recent decades may wane as globalisation retreats.
As deteriorating ties between the West, Russia and China and Covid after-effects drive globalisation into reverse, the world may see higher inflation and interest rates for quite a while.
