Stagnant Inflation Management

In recent times, the global economy has entered a strong inflation component based on ever-increasing energy and food prices. If the causes of price increases are limited to the region of Europe, and given that the EU is purely an importer of energy, one could argue that this is an “imported inflation” over which monetary policy has limited control.

However, an upward cycle of intervention rates is now considered necessary as it may reduce the part of inflationary pressures due to increased active demand.

The root causes of rising demand inflation at this time are many. The almost simultaneous exit of the economies from the pandemic recession combined with the accumulation of savings resources, due to reduced consumption during the lockdown period, were the main factors that led to a sharp increase in demand for many goods and commodities.

The expansionary fiscal policy pursued by most governments in the world, in order to support the pandemic sectors of the economy, has contributed significantly to the creation of these conditions, with the support of monetary policy. The latter secured low-interest lending to governments and businesses through its negative interest rate policy and the introduction of expanded quantitative easing programs. The strong and sudden rise in global demand has strengthened the pricing power of companies in many sectors of the economy.

In addition, there was a supply-side disruption in demand. The major exporting countries were facing difficulties in feeding the world economy. China’s manufacturing sector has suffered from a policy of zero tolerance for coronary heart disease, German industry has been hit by rising energy and raw material prices, and Ukraine, one of the world’s key granaries, is in the throes of an unexpected war. At the same time, global value chains and maritime transport responded to the rapidly rising demand with a long delay.

De-globalization trends, which were observed several years before the pandemic, as reflected in the prevalence of international trade flows, also reinforce the inflationary environment. The pandemic and subsequent war in Ukraine exacerbated these phenomena by violently altering the world energy map, as well as turning the financial sector into a weapon of the Western world through sanctions. Several studies estimate that the abolition of tariffs in China could lead to a significant de-escalation of prices of goods and raw materials worldwide.

Historically, it has been confirmed that a strong energy shock can trigger a stagnant inflation process. In the first phase, increased raw material prices lead to reluctance to undertake investment plans and weaken the purchasing power of households and their consumption. Inflation is basically a monetary phenomenon. The policy pursued is mainly responsible for maintaining high inflation, which either causes or does not prevent strong inflation expectations.

After the energy shock of the 1970s, there was an inability to control expectations. Back then, we had a loss of competitiveness due to the energy shock. Most governments in the free world reacted by slipping the hryvnia to recover, hence imported inflation, but the consolidation of strong expectations led to continuous appreciations and wage adjustments that eliminated which competitiveness gains achieved by the sliding of national currencies.

At the current juncture, as long as inflation expectations remain high, the risk of stagnant inflation is real for the euro area, especially if geopolitical instability persists on the continent. However, the institutional environment is quite different in Europe.

First, the central bank’s credibility in conducting monetary policy is much higher than that of the western central banks in the 1970s and 1980s (excluding the Fed and the BoE).

Secondly, the institutional framework for competition and the avoidance of excessive price increases by the business sector is much stronger, while the trade unions show prudence and restraint in their wage demands, analyzing the financial data and having enriched their strategy with experiences from the recent economic history.

It is certain that in the emerging environment, the weak links, member states with relatively lower credit ratings, will be under pressure.

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