Overcoming the COVID-19 pandemic and an effective peace process in Ukraine are the ideal solutions to harness inflation and its negative effects
The COVID-19 pandemic and the invasion of Ukraine by Russian forces have had a quick, progressive, negative impact on world economies.
The present outcry is inflation especially the retail index which varies between 4% and 9%. When it verges around double digit figures, this is when it is serious.
Inflation is the effect and not the cause. Inflation, by definition is a persistent increase in the general price level – which is being experienced. These events are also moving economies around the globe into a recession – a consistent three quarterly decline in the GDP, by definition.
Economics is about supply and demand. The pandemic and the invasion have hit out at supply. The pandemic made people stay at home fearing the unknown. Production fell. Efforts to work from home were made and in particular areas, especially the provision of services, this has been a success ushering in a new way of providing them.
The supply of goods has had a significant downturn causing scarcity of raw materials and world prices to rise and rise significantly.
The Ukraine invasion disrupted production of key products emanating from Ukraine like sun flower oil, wheat, cereals and similar items. Apart from the decrease in output, the invasion has for a significant period of time blocked the movement of goods through Ukraine bringing about a decrease in supply of other essential items causing supply to shrink with the effect of fuelling more inflation.
The Russian supply of gas has been compromised due to the sanctions that the EU and US have imposed in stages on Russia, causing a fall is gas supply, a disruption in production with the final consequence of also fuelling inflation.
Inflation hits people in all walks of life but it hurts those on basic wages, those with families but it does not hurt the well off.
Individuals and families on minimum or close to minimum wages experience a dwindling in the purchasing power of their income having no other option but to consume less or none at all. They do not have the luxury to move on with their life as their financial resources are what they earn each week. They see themselves moving towards the poverty trap and this is a very scary experience. They find themselves depending on financial support by the state and having to resort to beg from non-profit organisations.
Those with incomes well above the minimum wage, feel they can weather the storm by scrutinising every financial commitment they have, doing away with what they consider to be luxuries for a while without using their past savings and maybe saving some of it as interest rates become more attractive.
The few very well off do not even acknowledge that inflation is around. They might consider investing now before the price of their investment goes up.
Economic policies are being put into action with the main objective of controlling inflation – the most urgent issue that needs addressing.
The European Central Bank and the Federal Reserve and other Central Banks have gone for decreasing Quantitative Easing – this basically means “printing less money” (not to be taken literally). They have also embarked on increasing the interest rate which is in tandem with QE.
Why have these economic tools been applied? Decreasing the money supply, limits access to money for consumers thus decreasing aggregate demand. The increase in interest rates will see retail banks not pay charges for parking their excess liquidity with the central banks but now they will earn interest.
As retail banks can charge higher interest rates on lending plus earning interest when parking excess liquidity with the central bank, they can offer interest to their customers who will be induced to save if they have the money to do so.
This is basically monetary policy that attempts to tackle money supply with a final objective of restraining aggregate demand. It is a short term solution as the inflation being experienced is cost (of production) push type which makes the supply of goods and services more costly.
Domestic businesses will definitely experience a fall in demand for their goods and services as people have less disposable income with entrepreneurs having to shut down their business and as a consequence unemployment will begin to rise pushing more vulnerable people into the poverty trap.
Overcoming the COVID-19 pandemic and an effective peace process in Ukraine are the ideal solutions to harness inflation and its negative effects.
Until the ideal solutions occur and this will take time, supply side policies need to be put into place so that raw materials and finished goods emanating from Ukraine and Russia can be bought from other countries that grow them. This situation is also signalling other countries to divert their agricultural sector to growing essential items that were mainly imported from Ukraine and Russia.
They say history repeats itself and so does Economic history. Hopefully inflation and its negative effects on humanity will be overcome. This is a golden opportunity for solidarity between people where the strong help the weak thus overcoming the perennial problem of unequal distribution of wealth.
Peter G. Pace O’Shea is a teacher of Accounting and Economics at post-secondary level