If you have recently topped up the tank of your car, or boat recently, you will no doubt have winced at the price. It’s gone up a lot. When the price of fuel goes up, so does everything else. There can’t be a product on earth that doesn’t have the cost of fuel buried in its final price somewhere.
Much of the world is experiencing close to double digit inflation for the first time in nearly half a century, and it’s going to be as rough a ride this time, as it was way back then, if you are old enough to remember.
The spike in global prices of nearly everything has lots of complex causes. War in Ukraine and the restriction of supply of fossil fuels from Russia. The slow bounce back from the covid shutdowns have exposed labour shortages, and supply chain problems globally. And the effect of flooding the world economy with stimulus cash. Furlough payments, emergency loans and grants to shore up the economy during the pandemic has resulted in lots of printed money sloshing about that has also inflated prices. If you are British, then you also have the effect of Brexit in the mix, which is why the UK inflation rate is considerably higher than their European neighbours.
A little inflation is desirable to keep the economy ticking over nicely, around two percent is the general consensus, it makes wages rise sustainably, and encourages spending. Most developed nations are heading to the ten percent mark, with the UK forecast to be close to fifteen percent next year. It’s stacking up problems for many millions of people, as prices rise much faster than wages. Governments are keen to avoid an inflationary spiral, where people get paid more to keep up with rising prices, but the cost of their labour pushes prices higher still, and around we go again. Attempts to cap salary rises in the public sector lead to industrial action, and strikes, further disrupting the smooth running of the country.
So how do you fix it?
Central bank interest rates are a blunt tool, but it’s pretty much the only one they have to deal with inflation. The theory goes like this. Put interest rates up, it takes money from the economy as people are less likely to borrow, more likely to save so there is less money chasing the same number of goods and services so the price goes down. Even if you can get it to work, there are plenty of downsides, slow the economy too much, and you risk a recession, and taking money out of the economy tends to pile the pressure on marginal businesses.
There are also broadly two different kinds of inflation. Demand pull, this is the good news version, where an economy is doing so well, that consumers have too much to spend, and prices inflate to match, that´s the easy one to fix with higher interest rates. The other is cost push inflation, and that’s the one we have right now. Where the costs of production rise, and therefore so do prices, regardless of the spending power of the end consumer. If the costs of something is comprised of higher fuel costs, higher labour costs, supply chain problems and all the rest, then tweaking interest rates to blunt the spending power of your customers is not going to make the slightest difference. Unfortunately this is exactly the situation we find ourselves in, and this is exactly what the majority of central banks are doing to try to fix it.
It’s a tough time ahead for sure, with inflation picking up, and economies heading towards recession, we could be in a mire of ´stagflation´ The worst of both problems, with no clear route out.