The current inflation in many parts of the world has recently been linked to the Ukraine war. The ECB sees the reason for the fact that prices had risen significantly before this was due to the corona pandemic. But the causes of inflationary pressures across the board lie deeper.
Inflation rates have risen significantly worldwide since mid-2021. For May 2022, inflation was measured at 8.7 percent for Germany and 8.1 percent for the euro area. In the US, 8.6 percent was reached in May 2022. Consumer prices have also risen significantly in many developing and emerging countries. Egypt reported a value of 13.1 percent in April 2022, Brazil 12.1 percent and Sri Lanka even 33.8 percent.
Nevertheless, there were some countries with low inflation rates: In Japan, China and Switzerland, the inflation rates in April 2022 remained at a low level of 2.5 percent, 2.1 percent and 2.5 percent. Where are global inflationary pressures coming from and what are the differences?
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The recent global inflationary pressure has often been associated with the Ukraine war due to the sharp rise in energy, commodity and food prices. US President Joe Biden has therefore attributed seventy percent of the inflation in the US in March to Russian President Vladimir Putin. In the light of the war, the European Central Bank (ECB) also expressly referred to the importance of the sharp rise in energy prices for the high inflation in the euro area. ECB President Christine Lagarde sees the reason for the fact that the inflation rate had already risen significantly earlier in the corona pandemic.
But the causes of inflationary pressures across the board lie deeper. This has built up over a period of more than thirty years, since interest rates were lowered sharply in the USA during crises, but were not raised to the same extent in the recovery phases after the crises. Since every depreciation of the dollar put the other currencies in the global monetary system under pressure to appreciate, most central banks have followed the expansionary monetary policy of the USA since the 1990s. The global flood of money is now reflected in rising producer prices worldwide and – only partially! – reflected in sharply rising consumer prices.
Gunther Schnabl, born in Starnberg in 1966, Professor of Economic Policy and International Economic Relations and Head of the Institute for Economic Policy, University of Leipzig.
For many industrialized countries, inflationary pressures have not been visible for a long time due to the way inflation is measured in official consumer price indices. Starting in the 1990s, quality adjustments for measuring inflation have been pushed by the USA. The statistical authorities have increasingly used quality improvements – for example in the case of industrial products such as mobile phones and computers – to calculate the prices measured in shops downwards in the price statistics.
At the same time, there were no quality adjustments in the form of extrapolated prices for other product categories where quality losses can be assumed – such as services, where self-service has increased significantly, or food, whose production methods have become less sustainable.
Likewise, the weights of the goods represented in the consumer price indices were adjusted to the changed consumption habits. This is likely to have led to the price indices gradually replacing expensive goods with high price increases – such as solid wood furniture – by cheap goods with low price increases – such as chipboard furniture for self-assembly. Important groups of goods such as real estate, shares and public goods (e.g. roads, old age security and airports) were completely excluded from the price measurement. In the euro zone, in contrast to other countries such as Switzerland or the USA, even owner-occupied real estate is excluded from the inflation measurement, although the ECB has contributed to a significant increase in real estate prices with persistently low interest rates.
In many countries, subsidies play an important role in keeping prices in stores stable for a long time. With the ongoing low, zero and negative interest rate policies of the central banks, companies around the world that were able to pass on the interest rate concessions in the form of lower prices were subsidized. Likewise, numerous crises in many countries have undermined the bargaining power of unions, allowing price pressures to be kept under control along with wage costs. Almost all developed countries subsidize agriculture, which keeps food prices low.
The subsidies are particularly large in Japan, where the government has gained enormous additional spending leeway since the stock and real estate price bubble burst in the early 1990s thanks to the Bank of Japan’s immense purchases of government bonds. The Washington International Trade Association estimates that more than 40 percent of Japanese farmers’ income comes from the state. Generous aid for rice farmers has contributed to the fact that the price of rice has fallen significantly in recent years. In addition, wheat, soybeans, buckwheat and rapeseed (also used as animal feed) are subsidised.
Further subsidies can be found in rail transport, which plays an important role in densely populated Japan. State aid has pushed down school and university fees since 2009. Subsidies – most recently for electric vehicles – have repeatedly boosted demand for cars, so that their prices have remained largely constant since the 1990s. Fast-growing government co-payments have dampened the rise in health care prices. The state-controlled prices for water and electricity have only risen slightly. Gasoline wholesalers have been subsidized in response to the recent sharp rise in crude oil prices.
China is moving in a similar direction. In contrast to the USA, the significant increase in producer prices there has recently had no noticeable effect on consumer prices. This is likely due to the fact that the People’s Bank of China is pumping a lot of cheap liquidity into the corporate sector via the state-controlled banking sector and local governments in response to the Ukraine crisis. The prices of public services – which dominate the services represented in the price index – and the prices of manufactured goods – which are often produced by state-owned enterprises – appear to be set with the central government’s inflation targets in mind. Most recently, the comparatively restrictive financial policy and the corona lockdowns are likely to have dampened the politically dangerous inflationary pressure.
With the last price surge, driven above all by energy prices, the East Asian model could now also set a precedent in the European Union. Inflation in France, which is low by European standards, is probably due not least to the fact that gas and electricity prices there were already capped last autumn. In January 2022, the government in Paris decided to limit the increase in electricity prices to four percent this year. In response to the sharp rise in inflation, many countries in the European Union are now introducing comprehensive subsidies. On the one hand, these include direct payments to citizens – such as the one-off payment of 300 euros for every person subject to income tax in Germany – and on the other hand energy subsidies, which depress prices for consumers.
Germany has lowered the energy tax on fuels to the European minimum for three months and suspended the surcharge for renewable energy systems (EEG surcharge). The nine-euro ticket lowers the price of local public transport for three months. Austria wants to reduce taxes on gas and electricity for households and small businesses. Hungary’s Prime Minister Viktor Orbán has reduced electricity and gas prices by 25 percent and capped the prices for wheat flour, sugar and milk.
The Netherlands have reduced the energy tax once and will lower the value added tax on energy from 21 percent to nine percent from the summer. Poland has reduced the VAT rate for petrol and diesel from 23 percent to eight percent. The Czech government has canceled road traffic taxes. Romania has capped electricity and natural gas prices. In Italy there are no network charges and 25 cents are refunded for every liter of fuel. In Spain the reimbursement is twenty cents, while in Portugal the government sends out petrol vouchers.
Switzerland, which is considered a safe haven for capital inflows in the global inflationary environment, has found a special way of keeping prices low. If the large inflows of capital remained in Switzerland, this would not only drive up stock and real estate prices, but also fuel credit growth and thus inflation. However, by keeping interest rates well below US interest rates, the Swiss National Bank is facilitating large-scale capital outflows, which dampen domestic inflationary pressures.
If the Swiss National Bank also allows the franc to appreciate, as it has done in recent months, then the prices of imported goods will fall. There is increasing pressure on domestic companies and traders to keep prices down. In the past, Swiss citizens have therefore benefited from significantly lower inflation rates than citizens in the euro area.
While the amount of subsidized goods appears to be growing over time in many countries, the financing of rampant government spending remains open. With coffers largely empty and cuts in other areas of spending unpopular, many governments in the euro area – as in the case of Japan – appear to be relying on additional borrowing and thus the ECB’s purchases of government bonds. As a result, however, the money supply will continue to grow, which should continue to push up inflationary pressures in the longer term.
There is only one way to break out of this vicious circle: the central banks have to raise interest rates. Since this will restrict the spending leeway of the highly indebted euro states in the medium term and is bad for the economy, the ECB seems to be reluctant to take decisive steps, despite the first interest rate hikes that have been announced. Many other central banks, on the other hand, have already embarked on a clear course to increase interest rates. In the USA, the Federal Reserve (Fed) has ended bond purchases in light of high inflation rates and has signaled numerous interest rate hikes for 2022.
The Bank of England has hiked interest rates several times. Sweden’s Riksbank has implemented a fundamental change of course and brought forward the first interest rate hike. Central and Eastern European countries that have experienced reform, such as Poland, the Czech Republic and Hungary, have also raised interest rates. It remains to be seen whether these central banks will sustain their policy tightening stance in the light of mounting economic and political instability likely to accompany rate hikes.
Irrespective of this, one thing is certain: in the past, excessive government spending and persistently loose monetary policies have always been associated with economic and political instability. Hiding inflation with subsidies and price controls may justify continued loose monetary and fiscal policies in the short term, but it does not solve the problem of overspending. It is therefore to be hoped that the announcement of interest rate hikes in the USA and many other countries will herald the beginning of a global monetary and financial policy stabilization process.
Editor’s note: The article comes from the current issue of “Die Politische Opinion”, No. 575 – July/August 2022 of the Konrad-Adenauer-Foundation. The issue deals with the topic of inflation and was published under the title “Prices – When it gets more expensive”. You can find more articles here: https://www.kas.de/de/web/die-political-meinung/home
