An essay on the global inflationary pressures

Inflation is considered as an economic phenomenon. It is also a psychological phenomenon. That makes a deadly combination, especially in a democratic system, where the ruling party and the opposition parties speak different languages communicating different interpretations of the data made available. No wonder the economies (and economists) across the globe are under pressure to control the inflation. The Central Banks work overtime to control the inflation, sometimes designing new strategies with short term measures thus differing the immediate impact on the economies. US has been struggling with unprecedented increase in the inflation rate being highest in the last 30 years. One of the reasons for a high inflation rate is the supply chain crisis. With the spread of Civid virus, and the lockdowns in the manufacturing hub of the world — China, the global markets have faced lower than expected supply of the goods, thus pushing the prices up, resulting in inflation. Add to this the restricted supply of crude, the pressure on the economies dependent on import of crude has been unprecedented. Even as India, US and China used the strategic reserves, the OPEC+, especially Saudi Arebia and Russia, has been strategically strong in controlling the prices resulting in even more destabilized supply. In some of the economies, high inflation rate is accompanied with low growth, thus resulting in stagflation. According to some economists, US faces it at the moment. Add to this the lopsided economic activities after the spread of Covid, forcing the white color employees to move out of the job market, the share of wallet shifted the focus on essentials, putting pressure on the support sectors. Under these circumstances, what must the Central Bank do?

Do nothing: One the underline strategies followed by the Central Banks in a stagflation-affected economy is do nothing and expect the ‘things’ to settle down. If the situation does not change, the Central Bank start taking additional measures to tamper the inflation. According to some leading economists, this is what the Federal Bank is doing at the moment.

Do (at least) something: The political parties, especially in a democratic setups, are forced to ensure that inflation does not disturb the sentiments of the citizen, and this is where the Central Bank plays a role, at least to show they care. Some the methods used (and in use) include controlling the money supply in the system by changing the rate interest rates. More (and cheaper) money in the hands of the consumers would lead they to the market to spend it, thus oiling the economic mechanism in the short run. But this is possible only if the products (and services) are easily available in the marketspace. As Raghuram Rajan says, “This means that when the Fed does decide to move, it may have to raise rates higher in order to normalize financial conditions, implying a higher risk of an adverse market reaction when market participants finally realize that the Fed means business.”. At present, with the supply chain crises extending to the first half of 2022, this measure, according to me, may not work.

Take drastic steps: Some inflation is necessary of the economy. The trick is to maintain the right level of inflation. For me, this would start with calculating the real rate of inflation on a real-time basis. In many economies, we consider inflation at wholesale rates and then at retail rates with a clearly defined components for each of these calculations. In some cases, we also include some part of the inflation while calculating the GDP of the economy; the growth in the GDP may be because of inflation, but that’s a different topic to discuss. Looking at the history of leading economies, we have seen the fastest growing economies opened up to the concept of globalization, allowing the competitive advantage of nations to play a major role in the overall growth of the economy. However, we have also seen in the recent past some of the major economies now turning inward, moving away from globalization to bilateral and multilateral trade agreements, thus controlling the dependency on select nations, even as the intertwined growth within the economy takes some beating. The real issue here is to understand the role external factors (for example dependence on other economies) play in the internal performance of the economy. For the economies looking inward for corrections, may end up challenging the competitive advantage of nations in the mid to long term, thus reducing the dependency on others and getting the control of the economy in their own hands, at least theoretically.

Every economy needs ideal rate of inflation. The problem occurs when the inflation breaches the levels of comfort and starts impacting the economy. For now, I don’t see any action being taken by the Central Banks and wait for self-correction.