Inflation: A Necessary Evil?


Figure 1: Inflation – the most pressing economic issue of today


Inflation, we have all heard the word. We see it bandied about as part of everyday conversation, as a heading for news pieces or low-hanging fruit for campaigning politicians. The meaning itself is pretty straightforward – a general rise in the cost of goods and services. However, the underlying mechanisms and the task of finding consensus on the subject is anything but.


Aren’t rising prices just plain bad?

Economic growth is a complex process involving many different moving parts. While Economics is a field not given to universal accord, there is a general assumption that a low level of inflation is desirable and runs parallel to continued economic growth, “Most economists now believe that low, stable, and—most important—predictable inflation is good for an economy” (Oner, 2020). That is not to say, of course, that inflation is by default a good thing. The key here is moderation. “Thus, a high level of inflation today may or may not be bad news, but it can never be taken as good news, as far as the future income prospects of an economy are concerned.” (Andres & Hernando, 1997).


In justification of why inflation is, if not perhaps by default a good thing, then a necessary evil, we must consider the alternative. Deflation is characterised as a general fall in the price of goods and services and is by its nature associated with economic contraction, “When prices are falling, consumers delay making purchases if they can, anticipating lower prices in the future. For the economy, this means less economic activity, less income generated by producers, and lower economic growth.” (Oner, 2020)


Current Record Highs

As already cited, an established pre-requisite for a positive economic outlook is a steady low inflation rate. Sustained high levels are, of course, damaging as they impact people’s ability to purchase goods and services, in turn shrinking the size of the relevant markets and damaging people’s quality of life. In January of this year, the overall Inflation rate in the United States hit a 21st-century record of 7.5% (the United States Inflation Rate, 2022) the highest it has been since 1982. The Eurozone area also recorded record high Inflation levels in January 2022 at 5.1%, up from the previous high of 5% in December 2021 (Euro Area Inflation Rate, 2022).


That is nothing compared to the 13% rate seen in Pakistan last month (Rushe et al., 2022), or the extraordinary 36.1% recorded in Turkey in December of last year. Where in spite of calls to raise interest rates in order to help reduce spiralling costs, the Turkish government have thus far held fast. With unfortunately predictable results. Local officials in the capital Istanbul have cited the cost of living as having risen by an astonishing 50% in the past year alone (Turkey's inflation hits 36% amid financial turmoil, 2022). Inflation is rampant, and there are several reasons why economies across the globe are recording such historically high levels.


Figure 2: Rising oil and gas prices have greatly contributed to current global inflation rates


Rising Energy Costs

Increases across many different energy prices - primarily oil and gas – are certainly a key attributor. The nature of these price increases is itself a result of a variety of changing circumstances. Decreased capital investment from Oil companies throughout the 2010s has limited their ability to respond to rapidly changing market conditions – in this instance, by increasing production levels over a short time period. Production limits put in place by OPEC member countries – responsible for around 40% of the world’s crude oil production – have ensured that Supply has remained low in relation to the current demand surge. China, meanwhile, has been looking to limit its dependence on coal, in turn significantly increasing its demand for natural gas and driving gas prices up further in the process (Mullaney, 2021).


These issues will undoubtedly continue and almost certainly worsen over time as the world continues its attempts to come to grips with the realities of Climate Change and the need for significantly reduced carbon emissions. China’s ambitious attempts to achieve carbon neutrality by 2060 (Frangoul, 2020), alongside the EU’s carbon tax – due to be fully implemented in January 2026, will give a practical insight into just how traumatic some of these adjustments may be (Figures et al., 2021).


On a more immediate front, Russia and Ukraine's current situation means that heavy economic sanctions are likely to be placed on Russia by the global community over the coming weeks. Usually, that means higher tariffs – import taxes – on Russian oil and gas. The result? Once again, higher prices. In the context of existing energy costs being so high and Europe’s heavy dependence on Russian oil and gas, however, these sanctions may be tempered or at least directed elsewhere (Rappeport, 2022).


Supply Chain Disruption

All of us may have heard the phrase “Supply Chain Disruption” quite a lot throughout the past two years. The Supply Chain can be summed up as every process that is required to take place before a good reaches its final destination. Covid understandably then represented not so much an attack as an all-out assault on the Global Supply Chain. From factory closures to border restrictions, PPE (Personal Protective Equipment) shortages, and even the blocking of the Suez Canal. The Global Supply Chain has never been more sorely tested, at a time when the Global Economy has never been so interconnected. The basic economic logic that a reduction in Supply leads to an increase in prices remains tried and true. When something is scarce or limited, its value increases. Couple this with massive increases in consumer demand – a product of, amongst other things, increased savings generated over an extensive lockdown period and the easing of many Covid related restrictions – and there might be a recipe for rocketing inflation rates.


Figure 3: The Blocking of the Suez Canal in March 2021 added further to Global Supply Chain woes


Print it better

As any standard Economics textbook will tell, the root cause of inflation usually comes back to the Money Supply – and can be summed up as Central Banks printing too much money. The USA alone has committed a staggering $4.6 trillion in Total Budgetary Resources to Covid relief for the Pandemic (The Federal Response to COVID-19, 2022). Part of which even involved the direct provision of Financial stimulus checks to US citizens (Collins, 2022).


The EU has committed to an initial €800 billion Covid recovery fund (Boffey, 2021), alongside the €1.85 trillion that it already ploughed into its Pandemic Emergency Purchase Programme at the outset of the Pandemic in 2020 (Pandemic emergency purchase programme (PEPP), 2022). This marks a significant departure from the belt buckling “Austerity Era” preached by European Union officials in the aftermath of the 2009 global financial crisis. A strategy which they later admitted to having been a mistake (O’Leary, 2021).


Of course, there are arguments against excessive government expenditure, even in such extraordinary circumstances. For those arguing against though, it does bear the question – where would we be without it?


Figure 4: A world without inflation? Be careful what you wish for


An alternate history

The downside of Covid relief financing is that printing large sums of money creates an inflationary environment. The consequences of which ordinary people all over the world are living with today. In an alternate reality where no Covid-relief funding was supplied, a very different picture emerges - one of the unprecedented levels of unemployment. Mass falls in production to match falling demand – a product of cashflow crises rather than a lack of desire of consumers - Colossal deficits in Healthcare application, bankruptcies, and ultimately the inevitability of civil unrest.


Conclusion

In the face of enormous supply-side challenges and an inevitable fall in demand due to the general disruption brought about by the Covid-19 Pandemic. We might logically have expected to see significant levels of economic contraction on par with or above those last seen in the aftermath of the 2009 Financial Crisis. So far, this has not proven to be the case. Without direct Government intervention in the form of financial Covid relief measures, the impact of the Covid Pandemic would have been significantly more devastating. If the cost of easing this transition is rising inflation, it has very likely been worth the trade-off.




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Image Sources:


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James Duggan

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