Economy

Economy explainer: Why do some make a fuss of US inflation?

Published

2 years ago

May 23, 2021

In the last week many TV figureheads and politicians in the US have been speaking of rising inflation. Many economic commentators in Europe and Asia have also begun addressing this issue shortly after. Some see in recent data from Germany a hint of spill-over effectsto the EU and other developed countries. Others consider prices in the US a cautionary taleon the combined inflationary effects of re-opening, recovery and fiscal stimuli.

Yet, all these conversations may sound rather abstract for those who are not familiar with the meaning of inflation. Even more so for younger people who were not born yet at the time of the stagflation, in the 1970s. As a matter of fact, the term ‘inflation’ was trending on Google search as people tried to learn more. Thus, to understand why US inflation data are globally relevant one needs to lay down a few basic definitions.

What is inflation? An example

The term inflation describes one of the key phenomena of macroeconomics, which numerous scholars have studied attentively. Put it simply, inflation quantifies the increase (positive change) in the prices of a good or service over time.

In fact, it is intuitive that there are two basic factors on which prices almost always depend, to some extent. First, there is the use value of goods and services for the people who buy them. This is an ‘intrinsic’ valuedependent on “the physical properties of the commodity” or the welfare gain of the service. Second, the exchange value putting the good’s/service’s value in relation to that of all other goods and services. At the most basic level, the exchange value implies the possibility of a barter: an apple is worth two bananas.

However, and this is where inflation enters the scene, one can express a good’s exchange value also in monetary terms. Serving as a conventionally accepted unit of measurement, monetary prices express exchange value in an easily understandable and agreeable way.

Value use and exchange value

Clearly, these two forms of value are usually quite closely related, which makes it harder to grasp inflation.

Abstractly, the price (exchange value) of some foods is higher than of that of the same quantity of others. Concretely, let’s assume that a supermarket sells chicken breast meat at $7.00 per kilo and apples for $2.00 per kilo. The chicken-to-apple exchange value is $7/$2=3.5, which suggests that chicken’s use value is 3.5 times larger than for apples. Nutritionally, chicken is richer than apples as it contains 2.5 times more calories. Moreover, it is packed with proteins, which help keeping hunger at bay for longer. Thus, one of the reasons for the inequalities in prices lies in the differences in use value. In this example, in the fact that a chicken is more nutritious and filling than apples are.

Money’s value

Generally, the barter exchange value (for exchanges between goods) is what tends to remain more or less constant. The value use of meat may decrease in a world where more and more people are turning vegan or vegetarian. Yet, these tend to be marginal fluctuations. However, there is no intrinsic law that imposes a good to cost exactly that amount of dollars per kilo. On the contrary, the monetary exchange value (money-price or monetary price) of good for money is more unstable. The barter may remain stable even if the money-prices of several goods increase in the same proportion — say, 20%.

For instance, if the price of chicken and apples increased by 20% next year, they would cost $8.40 and $2.40. With a calculator one can easily find out that their barter exchange value would not change $8.40/$2.40=3.5. Yet, in 2021 one could buy five kilos of apples with $10. While the same note will only buy a little more than four kilos in 2022.

What has changed is the value of money itself.

Hence all the problems

The reasons why the value of money may change are various. Schematically, one can distinguish three types of inflation according to their source: (scarce) supply, (excess) demand or (expensive) inputs.

For start, if the goods and services that money buys become scarcer their use valueis going to increase. Even if there is not more money in circulation, prices of rare goods will rise — so-called supply inflation.

Similarly, like any other good or service, it is less worthy when it abundant. That is to say, as the central bank prints more money and the government signs more checks money devaluates. In fact, the more money people have, the more they will be able to spend. Usually, supply cannot adapt fast enough – you cannot raise chicken or grow apples overnight – there will be excess demand. In this situation prices also rise — termed demand inflation.

Finally, prices may increase because the price of one of more raw materials’ price is soaring (input inflation). An example of this mechanism is at play whenever the price of oil rises. In the previous example, transporting chickens and apples may become more expensive due to heightened gasoline and diesel prices.

Why to worry? Inflation and policy-making

Recently, inflation has not posed any problem in developed economies. If anything, the issue was actually the opposite: deflation or a reduction in prices due to enduring economic crises. Actually, inflation usually resembles a phenomenon as innocuous for an economy as the growth of men’s beard. In effect, a moderate inflation can be as beneficial as a beard is for some men’s appearance. If there was no inflation, people could just keep all their saving under the mattress, suffocating the baking system. As a consequence, small and medium enterprises without access to capital markets would be unable to borrow money to invest.

Thus, policymakers endeavour to strike a sustainable balance of positive but stably low inflation. Usually, the Central Bank’s mandate expresses this aim by pursuing an inflation somewhere close to 2%, but slightly lower. In other words, the same five kilos of apples that $10 would buy in 2021 should cost $10.20 in 2022. Hence the issue of how to measure inflation.

The Consumer Price Index

The standard approach employs the Consumer Price Index (CPI) and involves a representative basket of goods and services.Every year statistical agencies make inquiries about consumers’ habits to determine how much the ‘typical’ buyer spends on what. The higher the expenditure for a given good or service (e.g., apples as opposed to papayas), the ‘heavier’ its weight. And heavier weights mean that the same proportional change in monetary price generates more inflation all other factors being equal.

Here is a short example using US data. Let’s suppose that all the expenses related to housing increase by 10%, while medical care and apparel fall by 5%. All other expenses increase by 2% as per the Central Bank’s target. At the end of the year, total inflation will be 3.84% — without those decreases it would be over 5%.

The use of CPI inflation usually gives rather volatile results due to the relevant weight assigned to utilities and fuels. However, in normal times it is a rather trustworthy measure of how most people perceive the changes in prices. Yet, CPI figures are only as good as their reference basket. If the assortment hitherto analysed is representative of consumers’ real habits, CPI will provide powerful descriptions. But updating the basket takes time, and usually overhauls take place only every few years. Thus, when habits are changing fast due to an unpredictable exogenous shock, as with the lockdowns, the basket lags behind. True, the FED and other central banks to do not use CPI, but alternative measures that circumvent this problem. However, data collection remains an issue when policymakers have to take split-second decisions.

Paying attention to the data

According to established views, excessive inflation can turn into a pathology and bring a State on the brink of ruin. This is what happened in interwar Germany, when the State printed more money to face enormous expenses. Extremely high inflation (hyperinflation) rapidly devaluates saving and salaries, reducing people’s purchasing power — especially for the poorest earners and retirees. Yet, despite talks of unusually high inflation, no major economy is anywhere near alarming levels of inflation.

If anything, the current rise in prices is an optical illusion. Comparing today’s prices with those recorded last year, at the peak of the pandemic is misleading. As everyone knows, even an average-height person may look like a giant in comparison to a midget. Equally, current prices compared to those of last year’s look impressively higher. Yet, if the comparison is drawn with two years ago, the situation appears less alarming. The 24-month change in prices for selected goods is the easiest way to materialise the distortion in data for 2021. Figure 3 shows clearly that prices in the US are more volatile today than they were two years ago. But it also signals the presence of both inflationary and deflationary drives.

Conclusion: A temporary surge in inflation

In conclusion, the current soar in inflation in the US does not show the basic traits of a looming crisis. At least for now. A rise in prices is physiological after a recession. This time it may appear more intense because demand had not disappeared due to a generalised economic collapse. Rather, governments suppressed consumers’ desire to spend by imposing lockdowns while fiscal stimuli have been supporting income and demand.

Moreover, if China’s experience in forerunning post-pandemic recovery is of any help, inflation in the US will be temporary. In fact, all three sources of inflation are here at work, but they primordial causes are not systemic. First, there is a supply inflation because many factories shut down and ship floated in the harbours for several months. Thus, as demand returns there are several supply bottlenecks — which events such as the blockage of the Suez Canal worsen. Second, there is demand inflation since the end of lockdowns allows people to spend money in ways they could not. The rise in aggregated demand would have driven prices up in the short term even without supply slowdowns. Finally, there is input inflation because oil prices have picked up in comparison to their historical lows in 2020. This affects goods and services through higher transportation costs and prices for plastics, electricity, et cetera.

Thus, the initial rebound may be inebriating, but the hangover will not last. Even China has seen its recovery slowdown after the immediate post-lockdown boom — and inflation drop. And, assuming that this inflationary pressure will be temporary there can be some positive sides to it. A 3–4% rise in the CPI index for two–three months will not make central banks discontinue their stimuli. Moreover, some inflation may help some borrowers – especially small enterprises – and pave the way for a healthier recovery.

Economy

From Bullets to Development: Rethinking Military Expenditure in Favour of Official Development Assistance

Published

2 days ago

June 7, 2023

Rameen Siddiqui

International assistance has achieved remarkable accomplishments in reducing global poverty, supporting girls’ education, addressing hunger, ensuring safe childbirth, nearly eradicating polio, combating female genital mutilation (FGM), providing food rations for Syrian refugees, constructing schools and sanitation facilities in Kenya, and delivering crucial relief supplies to Afghan villagers affected by an earthquake.

However, despite the current combination of global crises, some of the wealthiest nations in the world are planning to significantly reduce their life-saving aid budgets in 2022-23. These decisions are made by political elites who are sheltered within the safety of their privileged positions, yet the consequences of these choices are acutely felt by the most vulnerable individuals across the globe.

Official Development Assistance (ODA) plays a vital role in supporting the development and welfare efforts of low- and middle-income nations. The United Nations has set a target for countries to allocate 0.7% of their Gross National Income (GNI) towards ODA. However, recent estimates indicate that a significant portion of foreign aid is being directed towards Ukraine, accounting for 7.8% of all ODA in 2022. Meanwhile, aid provided to least-developed countries and countries in sub-Saharan Africa has actually decreased. Donors continue to fall short of their targets to contribute at least 0.7% of their GNI to ODA. When considering a long-term perspective, it is evident that aid may still be experiencing a downward trend in comparison to what countries can reasonably afford.

.Despite its importance, the global levels of Official Development Assistance (ODA) have experienced minimal growth in the last ten years. This lack of progress in fulfilling the commitment to increase ODA to 0.7 percent of gross domestic product (GDP) places a burden on low- and middle-income countries. As a result, these nations are compelled to devise alternative development strategies that are less reliant on external aid. This situation presents them with difficult choices regarding the allocation of their scarce domestic resources undermining development in social sectors.

On the contrary, Military expenditure reached record level in the second year of the pandemic and world military spending continued to grow in 2021, reaching an all-time high of $2.1 trillion. This was the seventh consecutive year that spending increased, research published by the Stockholm International Peace Research Institute (SIPRI).

In light of the Monterrey Consensus on Financing for Development adopted in March 2002 and the 2015 Addis Ababa Action Agenda (AAAA), which outlines spending priorities, states are encouraged to set appropriate targets for essential public services like healthcare, education, electricity provision, and sanitation. However that might not be the case. The latest figures from the OECD will provide further support to the argument. Although there was substantial funding for Ukraine in 2022, Official Development Assistance (ODA) to some of the world’s poorest countries experienced a decline.

The data reveals a decrease of approximately 0.7% in bilateral flows to the group of nations categorized as the least developed countries, comprising 46 countries ranging from Afghanistan to Zambia. The total amount of aid provided to these countries amounted to $32 billion. In simpler terms, the data demonstrates that development aid to numerous developing countries actually contracted.

This leads to an abrupt reordering of budget priorities, where military expenditures, and humanitarian aid take precedence, while other critical needs like education and social services are likely to be deprioritized. Meanwhile, the convergence of droughts and conflicts causes immense human suffering and widespread hunger in several nations, and despite the urgent nature of these crises, UN humanitarian appeals for assistance consistently suffer from inadequate funding.

Assistance allocated to Ukraine, as well as any future major crises that require global attention, should be supplementary to the existing humanitarian and development budgets rather than compromising one for the sake of the other.

As we already knew, in 2021 the ODA budget was reduced to 0.5%, a drop of £3bn compared to 2020 to £11.4bn. The starkest impact of these cuts is on “least developed countries” (LDCs). The amount of bilateral ODA going to LDCs dropped by £961m in 2021, a cut of 40% taking it to a total of £1.4bn.

Yoke Ling, the Executive Director of Third World Network, commented that the increasing military expenditure will undoubtedly have a direct influence on various types of spending that developed countries have committed to providing for developing nations. This includes Official Development Assistance (ODA) and climate finance, which are legal obligations under climate treaties.

Furthermore, Yoke Ling highlighted that even prior to the Russian-Ukraine conflict, developed nations had already been reducing their financial support for development. Therefore, it is anticipated that this decline in development financing will further deteriorate in the future.

Given the climate-change-triggered floods in Nigeria and Pakistan, the severe food insecurity affecting millions in Nigeria, Ethiopia, South Sudan, Yemen, Afghanistan, and Somalia, the unfolding humanitarian crisis in Afghanistan resulting in widespread starvation and desperate measures such as selling body parts to provide for families, the ongoing refugee crisis in Syria where millions remain in displacement camps even a decade after the conflict started, and the devastating famine gripping Tigray, advocates concur that there is an urgent need to uphold and potentially enhance international aid more than ever before.

According to a UN report titled “2022 Financing for Sustainable Development Report: Bridging the Finance Divide,” the Official Development Assistance (ODA) experienced a remarkable growth, reaching its highest-ever level of $161.2 billion in 2020. However, despite this record growth, the report highlights that 13 countries reduced their ODA contributions, and the overall amount remains insufficient to meet the significant needs of developing countries.

The UN expresses concern that the crisis in Ukraine, coupled with increased spending on refugees in Europe, may result in reductions in aid provided to the poorest nations. The majority of developing countries require urgent and proactive support to get back on track towards achieving the Sustainable Development Goals (SDGs).

According to the report’s estimates, a 20 percent increase in spending will be necessary in key sectors within the poorest countries.

If certain developed nations allocate generous resources to military expenditures while simultaneously reducing funding for other aid programs, are they implying that security interests take precedence over long-term public needs? Without question, the rights and necessities of people in Ukraine, Asia, and the rest of the Global South should be prioritized over military spending. Moreover, apart from the conflict in Ukraine, developed countries have already failed to fulfil their commitment of providing $100 billion of climate finance by the year 2020.

By compromising development aid budgets and climate finance, the consequences of poverty, inequalities, adverse climate impacts, and exclusion in the global South will be exacerbated. Such a lack of ambition risks reinforcing the economic and political grievances that lie at the core of armed conflicts in various regions, including Asia.

In order to uphold solidarity and justice, there is a pressing need for synergized political will and ambition.

We should challenge developed countries to honour their existing aid commitments, which include allocating a minimum of 0.7% of their Gross National Income (GNI) as Official Development Assistance (ODA). Additionally, we also call upon them to provide new funding to address the needs of the people in Ukraine. It is imperative to identify new avenues for grants-based climate finance to compensate those most affected by climate change, including communities experiencing losses and damages.

The UN report on Financing for Sustainable Development also highlights the stark contrast between rich countries, which were able to support their pandemic recovery through substantial borrowing at very low interest rates, and the poorest nations that had to allocate billions of dollars to service their debts, hindering their ability to invest in sustainable development.

As we approach the midpoint of funding the Global Sustainable Development Goals, the discoveries are deeply concerning. We cannot afford to be inactive during this critical moment of shared responsibility, where our aim is to uplift hundreds of millions of individuals out of hunger and poverty. It is indispensable that we prioritize investments in equitable access to decent and environmentally friendly employment, social protection, healthcare, and education, leaving no one behind.

Economy

Meeting of BRICS Foreign Ministers in Cape Town: gauging the trends ahead of the summit

Published

3 days ago

June 6, 2023

Yaroslav Lissovolik

Image source: twitter @BRICSza

The meetings of BRICS foreign ministers in Cape Town on June 1-2 were awaited with notable impatience by the global community as several themes in BRICS development were very much in the spotlight throughout this year. One theme was the process of de-dollarization of BRICS economies and the possible creation of a BRICS common currency. Another theme was the discussion on the possible expansion in the BRICS core membership as nearly 20 developing economies have indicated their intention to join the block. Perhaps for the first time in more than a decade these issues made it into the Western mainstream media as the potential implications of BRICS decisions on the common currency and membership could have a major effect on the evolution of the global economic system.

As regards the issue of the creation of a new currency, the BRICS Foreign Ministers placed the emphasis on the use of national currencies in mutual settlements. The cautious approach of BRICS to the issue of the common currency thus far may be due to the need to consider all possible modalities of such a currency, including whether it is to be used as a means of mutual settlements, an accounting unit or as a reserve currency. At the same time, it does appear that the New Development Bank (NDB) was charged with producing a blueprint of how the common BRICS currency could be created and used in mutual transactions. Fundamentally, it appears that all BRICS economies see de-dollarization and the creation of alternative settlement instruments as expedient – the question is what are the common BRICS initiatives in this area that would be seen as optimal by all core members. There may be more substantive discussions on the BRICS common currency at the August summit, with further progress made in 2024 during Russia’s BRICS chairmanship.

With respect to the issue of the block’s expansion the BRICS Foreign Ministers have indicated that work is still ongoing on defining the criteria for new members. No concrete “priority candidates” were singled out. The gradualism in the expansion process is warranted as there may be risks associated with the expansion in the ranks of the BRICS core – the decision-making process is likely to get more complicated at a time when BRICS are set to make crucial decisions with sizeable long-term implications not only with respect to BRICS own future but also for the global economy. In the end BRICS members may come to the conclusion that expanding the BRICS core is problematic and that other formats such as the BRICS+/BRICS++ or a permanent “circle of friends” that participate in the BRICS summits may be preferable. In this respect, it is important to look at the modalities of BRICS meetings with the so-called “Friends of BRICS” that were held during the second day of meetings on June 2.

The meetings of the “Friends of BRICS” featured such economies as Iran, Saudi Arabia, the United Arab Emirates, Cuba, Democratic Republic of Congo, Comoros, Gabon, Kazakhstan as well as Egypt, Argentina, Bangladesh, Guinea-Bissau and Indonesia. Some of these countries were invited from within the group of those that had earlier applied to join the BRICS block, while others featured as representatives of the respective regions and regional associations of the Global South. To some degree the composition of the countries invited into the “Friends of BRICS” circle may offer insights into the format of the BRICS+ meetings at the summit in August later this year.

Overall, South Africa is sustaining the impulse towards greater BRICS openness after the BRICS+ meetings last year during China’s chairmanship. And while a full-fledged admission of new members into the BRICS core appears unlikely in the very near term, there may be further advancements made by BRICS in developing the BRICS+ format and setting the stage for a greater cooperation of BRICS with other developing economies and regional integration blocks. As regards de-dollarization and the creation of a new BRICS currency, the most important development is that these issues are now squarely part of the BRICS agenda, which raises the prospects of material changes on this front in the coming years.

Author’s note: first published in BRICS+ Analytics

Economy

Has Sri Lanka Recovered from the Economic Crisis?

Published

4 days ago

June 5, 2023

Syed Raiyan Amir

Sri Lanka is navigating an unparalleled economic crisis, and according to the Asian Development Bank’s (ADB) annual report, the Asian Development Outlook (ADO) April 2023, the country’s GDP would continue to decline in 2023 before starting to slowly recover in 2024. In 2022, the economy shrank by 7.8%, and in 2023, it is expected to shrink by 3% as it continues to struggle with debt restructuring and balance of payments issues. The country’s efforts to stabilize its economy will be aided by reform measures including the rollback of the 2019 tax cuts and the recent acceptance of the Extended Fund Facility agreement with the International Monetary Fund (IMF). The speedy resolution of the debt issue and the unwavering execution of reforms are essential to Sri Lanka’s recovery from the crisis.

However, due to policy mistakes, global economic shocks, rivalries among the big powers, and pre-pandemic macroeconomic vulnerabilities, Sri Lanka was already in a precarious position when the crisis began. In 2022, a lack of foreign currency caused a shortage of goods that were necessary for survival, as well as an acute energy crisis that resulted in protracted power outages and traffic jams since Sri Lanka was running low on fuel. Many fell into poverty as a result of rising inflation and declining living conditions. The poor and vulnerable have suffered disproportionately from the economic crisis.

While different economic packages have been sanctioned for the island state and relatively sound political stability is on the eve, it can be perceived that an upward movement may be seen in the next year. This year is the year of policy reformations, then the reaping time will be 2024. Meanwhile, the Sri Lankan currency last appreciated versus the dollar by 4.5 percent on March 14. The writeup will therefore shed light on the prospects of economic upwardness.

Finally receiving approval from the IMF for a $3 billion rescue package for Sri Lanka, the island nation may now restructure its debt and expect economic growth in 2024. The IMF’s decision will enable for the prompt disbursement of a $333 million loan over four years to the South Asian nation, which is currently experiencing its worst financial crisis in decades. According to IMF director for Asia and the Pacific Krishna Srinivasan, Sri Lanka has been “hit hard by catastrophic economic and humanitarian crisis.” In an interview with CNBC’s Sri Jegarajah in Asia, he said, “This you can trace back to three factors: One is pre-existing vulnerabilities, policy mistakes, and shocks.”

However, Ranil Wickremesinghe, a six-time prime minister, was elected president by the nation’s lawmakers in July. Wickremesinghe congratulated the IMF in a tweet in response to the most recent IMF bailout and stated that his nation is dedicated to its “reform agenda,” adding that the IMF program is “critical to achieving this vision.”

Previously, as mentioned, the biggest economic crisis the island nation has seen since gaining independence began in early 2022, according to the Central Bank of Sri Lanka, and is projected to gradually cease in the second half of this year. According to Xinhua news agency, the central bank stated its monetary policies for 2023 on January 4 and noted that the sharp acceleration of inflation that started in early 2022 reversed in October. “The Sri Lankan economy, which is projected to register a real contraction of around 8.0 percent in 2022, is expected to record a gradual recovery in the second half of 2023 and sustain the growth momentum beyond,” the bank stated.

According to a recent study by the Central Bank of Sri Lanka, the GDP of the nation increased by 3.6% in the first quarter of 2023 compared to the same time in 2012. Compared to the previous quarter, when the GDP expanded by just 1.5%, this is a huge increase. This development has been attributed to a variety of factors, including increasing industrial production and greater demand for Sri Lankan exports. Particularly, the manufacturing industry has experienced rapid development, with production rising 6.9% in the first quarter of 2023. The agricultural industry has also done well, with considerable increases in tea and rubber exports. Additionally, there have been indications of a rebound in the tourism sector, as seen by a 29% rise in visitor arrivals in the first quarter of 2023 compared to the same period in 222. Given that the tourist sector has been one of the hardest hit by the COVID-19 pandemic and associated travel restrictions, this is particularly noteworthy.

However, since Sri Lanka’s governmental collapse and near-bankruptcy last summer, there appears to be a return to calm in the South Asian country. Fuel lines that once snaked for blocks have been removed, and a beachside area that had been the location of a protest camp for months was decorated for the holidays with Christmas lights and carnival rides. Moreover, the island’s economy still runs on a ventilator since the government has not found a solution to escape its crippling debt. Sri Lankans have come to terms with a depressing reality that includes fewer meals, smaller paychecks, and lower aspirations.

Meanwhile, instead of fixing the economy, a series of punitive tax hikes and subsidy reductions that further limited demand have brought about a semblance of stability. Although necessary, the actions are unpopular and provide fodder for the political opposition, increasing the likelihood that this administration or the one after it will back off from them. Therefore, the economy is still running on a thin line.