The Cost of Inflation: A threat to global economic growth

The Cost of Inflation: A threat to global economic growth. Quynh Nguyen, Runner Up in the CoBS 2023 Student CSR Article Competition at IE Business School, explores the spiral of inflation that has swept the world, highlighting the inability for supply to keep up with demand.

Quynh Nguyen, Runner Up in the CoBS 2023 Student CSR Article Competition at IE Business School, explores the spiral of inflation that has swept the world, highlighting the inability for supply to keep up with demand

How can I even buy a loaf of bread with only 200 pesos?” thought Elena, as she stood in front of the bakery staring at the loaves of bread displayed in the window. She had come to realize that the pursuit of a full life was becoming a luxury that only a privileged few could afford. Elena had always struggled to make ends meet, but with global inflation in 2022, her financial situation had become unbearable.

Student Voice at the CoBS: The Cost of Inflation: A threat to global economic growth by Quynh Nguyen, IE Business School

Elena was a single Argentinian mother of two young children and worked long hours as a waitress to support her family. Despite her hard work, she was barely able to pay for the basic necessities like food, rent, and utilities. Every day was a struggle to keep her head above water.

One day, while at work, Elena overheard a conversation between two customers about the soaring inflation rates. She realized that she was not alone in her struggles and that many people around the world were facing the same difficulties.

It is clear that the impact of inflation was felt not only by individuals like Elena but also by entire economies and nations.

For many developing countries, high inflation is a constant risk. The last time inflation was as high as it was in 2022 in major economies was in the early 1980s. In the US, consumer prices are on track to rise about 7% in 2022, the highest level in four decades. In Germany, the rate is close to 10%, the first double-digit inflation since 1951.

Inflation has made a comeback and is causing concern for individuals, governments, and central banks around the world.  Prices of many consumer goods have been on an upward trend in early 2022 due to the lingering impact of COVID-19 on the supply chain.

As soon as the COVID-19 pandemic was contained, with the widespread coverage of the vaccine and the efforts of the governments of other countries in implementing expansionary fiscal and monetary policies, the world’s economy came out of recession. As a result, in 2021, the world economy recovered spectacularly with a growth rate of 5.9%, of which developed countries will reach 5.2% and emerging and developing countries will reach 6.4%. The US economy, the world’s leading economy, grew by 5.7%, the highest growth rate since 1984.

Entering 2022, the world economy faced many uncertainties, including expansionary fiscal and monetary policies, disruption of supply chains, food crises, and especially the energy crisis due to geopolitical instability. The failure of supply to meet the sudden increase in demand after the pandemic is one of the main reasons for high inflation in developed economies, such as the United States and the European Union (EU), as well as in emerging and developing economies.

The Russian-Ukrainian conflict in February made the situation even more complicated. Oil prices rose about 30% as Western countries introduced sanctions against Russia, a major crude oil producer. Food prices have also increased sharply due to fertilizer and transportation costs, as well as Russia’s blockade of grain exports from Ukraine.

This is equivalent to a shock in terms of economics. Sudden price increases for key commodities have quickly crept into the daily lives of people around the world. Millions of people in Europe, which has traditionally relied on Russian gas, struggled in the winter to stay warm. By 2022, food and fuels had accounted for more than half of total inflation.

The Cost of Inflation: A threat to global economic growth. Quynh Nguyen, Runner Up in the CoBS 2023 Student CSR Article Competition at IE Business School, explores the spiral of inflation that has swept the world, highlighting the inability for supply to keep up with demand.

It would be bad enough if inflation were only a supply-side phenomenon. The pressure that has crept into the “core” components of the price index, or the commodities and services outside of volatile food and energy, is, however, the most concerning development for central banks.

Inflation combined with a low unemployment rate and a strong labor market, particularly in the USA, has caused wages to increase, increasing the risk of falling into the “wage-inflation spiral.” Global inflation was forecast to peak in 2022 at about 7.7%, more than twice as much as in the previous period. The International Monetary Fund (IMF) forecast that inflation in 2022 would increase, and consumer prices are expected to increase by 6.6% in developed economies and 9.5% in emerging and developing markets.

The world economy has suffered from an inflationary storm that formed in mid-2021, strengthened into a “storm” in 2022, “swept” and brought the world economy into the highest inflation period in Over the past 40 years, prices have been steadily climbing. In 2023, world inflation will gradually decrease but will still be much higher than the target inflation rate in most countries.

Because of the flood of early retirements during the epidemic, many countries presently have very constrained labor markets. As a result, companies are paying higher wages to attract workers, further fueling inflation.

There are concerns almost everywhere that rising prices may reset people’s expectations of inflation, leading them to demand greater wages and making inflation much harder to eliminate. That reason was enough to get the central banks to act. The most active central bank has been the US Federal Reserve (FED), which increased interest rates from a floor of 0% in March to more than 4%, the largest tightening of the money supply in forty years. Central banks around the world are doing the same thing as the Fed.

Risk. Navigating the complex world economy in 2023

In 2023, it is forecast that the world economic and political situation will continue to evolve rapidly, complicatedly, and unpredictably with many uncertain risk factors; global inflation in 2023 is forecast to decrease but still be much higher than the inflation target of central banks; high inflation remains the biggest risk for many economies. Countries continue to raise interest rates and implement tight monetary and fiscal policies. The world’s financial and currency markets have potential risks and uncertainties. The unresolved conflict in Ukraine will affect gasoline prices, transportation costs, logistics, production and consumption supply chains; the risk of destabilizing energy and food security; and extreme weather events caused by climate change will put pressure on energy.

Prices of energy and food have many potential risks of complicated and unpredictable fluctuations, and although the prices of these two commodity groups have decreased, they are still at a high level. The oil price forecast for 2023 will be about 92 USD/barrel, 40% higher than in 2021. Many assessments believe that energy and food prices will continue to fluctuate sharply, especially in the face of the complicated and prolonged developments of the Russia-Ukraine crisis.

Beginning 2023, China gradually phased out the “Zero-Covid” policy and reopened its economy. When the economy improves, China will increase imports of crude oil, manufacturing materials, and industrial goods, pushing up world raw material prices and putting upward pressure on the prices of many consumer goods and other commodities. other services, then global inflation will rebound. If China fully opens up by mid-2023, Bloomberg estimates, energy prices will increase by 20%, and US CPI, forecast to fall to 3.9% by mid-year, is at risk of skyrocketing to 5.7% by mid-2023.

In that context, in 2023, the top priority of governments will be to curb and control inflation, ready to trade off economic growth. Leading economies continue to implement tight monetary policies, raising interest rates to control inflation and prevent inflation expectations. Currently, about 90 countries have raised interest rates, with the highest number of interest rate hikes since 1970. The Fed affirmed that it will continue to raise interest rates to control inflation. The Fed is expected to raise the basic interest rate above 5% in 2023, despite the risk of a slowdown in economic growth. IMF Director Kristalina Georgieva advised central banks to continue raising interest rates further to curb inflation until interest rates return to “neutral”.

In order to cope with the appreciation of the USD, besides raising interest rates, countries will continue to take strong measures to prevent the devaluation of the local currency, which means preventing the exchange rate between the local currency and the USD currency from rising.

The winners and losers of this inflationary environment are not evenly distributed. In contrast to people who rely on fixed salaries or live pay check to pay check, those who have investments in tangible assets like real estate or gold can profit from the price increase. Food and fuel prices have increased, making it difficult for low-income households to afford basic necessities.

The job market is where the new societal conflicts brought on by inflation are most conspicuous. Companies are offering higher wages to attract workers, but this can lead to higher prices for goods and services, contributing to a vicious cycle of inflation. Additionally, people who are unemployed or underemployed could harbor anger toward others who are able to profit from the current inflationary situation.

The conflict between dropping demand and recovering supply will determine inflation in 2023. Most likely, some of the variables that fueled inflation in the first half of 2022 have already started to subside. Prices for consumer items have decreased as supply networks have become more regular. Oil prices have returned to where they were a year ago, in part due to increased output. Demand is suppressed, which tightens monetary policy.

The sectors most sensitive to interest rates are being hit hard, and the real estate market is gloomy. Before a severe recession hits, the central bank may decide to ease monetary policy if the recovery in supply, which is essentially the availability of employees, is significant and quick. However, at this point, it seems more likely that worker sentiment will do real damage to the global economy. In 2023, worries about inflation could give way to worries about unemployment.

In 2022, inflation returned, causing concerns among individuals, governing bodies, and central banks all around the world. One of the main causes of high inflation in industrialized economies like the United States and the European Union (EU), as well as emerging and developing countries, is the inability of supply to keep up with the abrupt surge in demand following the pandemic. As a result, major commodities experienced abrupt price rises that soon seeped into people’s daily lives all around the world. The stability of the world economy is in danger of an inflationary maelstrom.

For a full list of references used in this article, click here.

Quynh Nguyen, Runner Up in the CoBS 2023 Student CSR Article Competition at IE Business School
Quynh Nguyen

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