7.8 C
Sunday, January 29, 2023

Inflation ideology: permanent or temporary?

Must read

Inflation ideology: permanent or temporary?

The revelation of the latest mutation of the coronavirus, Omicron, sent the stock markets into a free fall. But only for one day, as they recovered quickly the next. Markets, like experts, seem to have a lot of faith in the ability of our economies to adapt.

This is a bit strange if we consider that the current mutation, Delta, brings us again to the brink of closing the economy in Europe. Some countries have already imposed such restrictions, extended the Christmas school holidays and forced teleworking again.

Were last month's optimistic forecasts for growth too early?

On the one hand, it is a fact that the economic impact after each new pandemic wave is diminishing. On the other hand, Omicron's perspective confirms the enormous uncertainty we will continue to face.

Nowhere do we see this uncertainty more than in the debate over inflation. The annual inflation rate we expect in the eurozone this year is 2.4%, just above the 2% target set by the European Central Bank (ECB). However, in recent months inflation has been much higher than this, due to both rising energy prices and delays in receipts from Asia.

And the question is: is this increase temporary or will it take long enough to consolidate inflation after a long period of very low inflation? Depending on your position on this issue, the ECB will have to choose between waiting or intervening.

As long as the rise in inflation is due to supply-side reasons, namely energy and congestion in global supply chains, the ECB cannot intervene.

This does not mean, however, that the consumer will not feel the weight of the higher prices in his wallet. Indeed, governments across the European Union (EU) have put in place measures to protect consumers from this rise in energy prices. If the Omicron mutation worsens supply chain congestion, then there will be additional upward pressure on prices.

At some point, the average consumer may be dissatisfied with the government's temporary help and start asking for a raise to cover their expenses. If this happens on a large scale, then a vicious cycle of rising prices and wages will be created, which is a toxic mixture for inflation, known as second-round effects.

At the moment, the vicious circle has not begun, although there is definitely pressure. And as it takes about two years to see the impact of any change in monetary policy, there are those who are urging the ECB to intervene as soon as possible.

In an environment of enormous uncertainty like now, it is not wise to have strong views on where inflation is heading. The structural reasons why inflation has been so low for so long have not disappeared. But at the same time the nervousness we are currently seeing in price changes is real and visible. It is not at all unlikely that inflation will remain high for some time and, therefore, either be considered “permanent” or even become longer-term. If employers start raising wages to calm demanding workers, then the ECB should take action.

Added to this is the real difficulty of knowing what the right measures are. We must acknowledge that the ECB is in a very difficult position. Rising interest rates to avoid persistent inflationary pressures could jeopardize the one thing the ECB was trying to avoid, financial fragmentation in Europe. The last thing we need now is to widen interest rate fluctuations which would jeopardize the recovery, or even the single currency itself.

Reducing the quantitative easing program for the pandemic is the other option the ECB has, but such a measure would limit countries' lending capacity. For Greece, this is crucial as long as its debt remains below the investment grade threshold and thus prohibits its inclusion in other quantitative easing programs. For the rest of Europe, given that the economy is indeed growing as fast as we can see, it may not be a bad time to think about reducing fiscal support, as debts cannot grow forever.

At present, policy-making should be guided by uncertainty. It thus requires close monitoring of developments, avoidance of guiding policies for the euro area based on what is happening in only a few countries, and the adoption of such policies that will provide satisfactory results for a wide range of developments.

Meanwhile, the pandemic is not over. And the enormous uncertainty brought about by the ripples of the pandemic is not over as we pass from the micron, to the pi, to the ro…

* Deputy Director of Bruegel, Research tank (think tank) based in Brussels. This text was originally published in the newspaper Kathimerini Ellados, as an opinion column on the Bruegel Blog, and on the Blog of the Cyprus Economic Studies Society (cypruseconomicsociety.org)

Source: politis.com.cy

- Advertisement -AliExpress WW

More articles

- Advertisement -AliExpress WW

Latest article