If history teaches us anything about high inflation, it’s that we have to suffer to keep it under control. The more inflation has gotten out of hand and the more stubborn it is, the more painful it is to fight.
This is a column by BNR’s in-house economist, Han de Jong.
It is clear that inflation has gotten out of control. The central bankers who first told us inflation would be temporary have long warned that it is more stubborn than hoped. So the logical conclusion seems that we will have to suffer a lot to control inflation. In the “real” economy, the pain consists of contraction, recession, bankruptcies and, above all, rising unemployment, and in financial markets mainly a sharp decline in stock prices.
“So far, inflation is coming down painlessly. Whether this will continue is uncertain. ‘
How is it possible?
However, we see something very different. Inflation is rocketing down and is almost certain to hit central banks’ 2% target or even fall below it in the coming months. Yet it is not economic suffering, while investors are certainly not in mourning but in celebration. The AEX is more than 10% higher than at the beginning of the year and the Nasdaq even 40%. How is it possible?
I see four possible explanations for the recent developments. The first is that the pain it has suffered in the past to keep high inflation in check has been caused by central banks. They may have gone too far with their rate hikes. This time they have found the narrow and slippery path between doing too little and doing too perfect. Gift.
A second explanation is that the pain is yet to come. The increase in interest rates has not yet fully materialised, and corporate earnings are under increasing pressure. From this perspective, rounds of layoffs and lower stock prices are expected due to falling corporate earnings. For now, however, that is not yet the case.
Yet temporary
A third explanation is that the decline in inflation is only temporary. This is caused by base effects, such as falling energy prices, falling food price inflation and, in the US, lower rent inflation. The underlying picture is less favorable and once the temporary inflationary effects disappear, a fairly persistent inflationary problem remains. Fighting it will be accompanied by the usual pain.
To gauge how likely this scenario is, I look at wage developments. The image below gives the impression that wage growth has passed its peak. For now, however, it remains much higher than necessary to keep inflation at the 2% target over time.
Source: AWVN and Atlanta Fed
Very different from the 70s
A fourth explanation is that the high inflation of recent years cannot be compared to, for example, that of the 1970s. The inflation was initially caused by a tripling of the price of oil and accommodative fiscal policy. A few years later, the price of oil tripled again.
This time, the inflation was initially caused by bottlenecks that led to an explosion in transportation costs and some commodity prices. Now they have normalized. The central bankers were right that these developments were temporary. Now that they’re reversed, they push inflation down just as hard.
Subsequently, energy prices have increased. After the outbreak of war in Ukraine, the price of oil soared to double its pre-pandemic level and the price of European gas to more than 2000% above that level. The big difference from the 1970s, however, is that energy prices have fallen again. Oil is now only slightly more expensive than it was in 2019. The price of gas in Europe is about 92% lower than its peak in August last year, although the price is still double what it was before the pandemic.
So far, inflation is coming down painlessly. Whether this will continue is uncertain. What is certain is that the possibility is greater than in the 1970s because the inflationary process is very different from then. Ultimately, wage developments are decisive.
Source: BNR
Andrew Dwight is an author and economy journalist who writes for 24 News Globe. He has a deep understanding of financial markets and a passion for analyzing economic trends and news. With a talent for breaking down complex economic concepts into easily understandable terms, Andrew has become a respected voice in the field of economics journalism.
