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.
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 Contradicts Democracy: Russian Markets Boom Amid Political Sabotage
The political game plan laid by the Russian premier Vladimir Putin has proven effective for the past two decades. Apart from the systemic opposition, the core critics of the Kremlin are absent from the ballot. And while a competitive pretense is skilfully maintained, frontrunners like Alexei Navalny have either been incarcerated, exiled, or pushed against the metaphorical wall. All in all, United Russia is ahead in the parliamentary polls and almost certain to gain a veto-proof majority in State Duma – the Russian parliament. Surprisingly, however, the Russian economy seems unperturbed by the active political manipulation of the Kremlin. On the contrary, the Russian markets have already established their dominance in the developing world as Putin is all set to hold his reign indefinitely.
The Russian economy is forecasted to grow by 3.9% in 2021. The pandemic seems like a pained tale of history as the markets have strongly rebounded from the slump of 2020. The rising commodity prices – despite worrisome – have edged the productivity of the Russian raw material giants. The gains in ruble have gradually inched higher since January, while the current account surplus has grown by 3.9%. Clearly, the manufacturing mechanism of Moscow has turned more robust. Primarily because the industrial sector has felt little to no jitters of both domestic and international defiance. The aftermath of the arrest of Alexei Navalny wrapped up dramatically while the international community couldn’t muster any resistance beyond a handful of sanctions. The Putin regime managed to harness criticism and allegations while deftly sketching a blueprint to extend its dominance.
The ideal ‘No Uncertainty’ situation has worked wonders for the Russian Bourse and the bond market. The benchmark MOEX index (Moscow Exchange) has rallied by 23% in 2021 – the strongest performance in the emerging markets. Moreover, the fixed income premiums have dropped to record lows; Russian treasury bonds offering the best price-to-earning ratio in the emerging markets. The main reason behind such a bustling market response could be narrowed down to one factor: growing investor confidence.
According to Bloomberg’s data, the Russian Foreign Exchange reserves are at their record high of $621 billion. And while the government bonds’ returns hover at a mere 1.48%, the foreign ownership of treasury bonds has inflated above 20% for the second time this year. The investors are confident that a significant political shuffle is not on cards as Putin maintains a tight hold over Kremlin. Furthermore, investors do not perceive the United States as an active deterrent to Russia – at least in the near term. The notion was further exacerbated when the Biden administration unilaterally dropped sanctions from the Nord Stream 2 pipeline project. And while Europe and the US remain sympathetic with the Kremlin critics, large economies like Germany have clarified their economic position by striking lucrative deals amid political pressure. It is apparent that while Europe is conflicted after Brexit, even the US faces much more pressing issues in the guise of China and Afghanistan. Thus, no active international defiance has all but bolstered the Kremlin in its drive to gain foreign investments.
Another factor at work is the overly hawkish Russian Central Bank (RCB). To tame inflation – currency raging at an annual rate of 6.7% – the RCB hiked its policy rate to 6.75% from the all-time low of 4.25%. The RCB has raised its policy rate by a cumulative 250 basis points in four consecutive hikes since January which has all but attracted the investors to jump on the bandwagon. However, inflation is proving to be sturdy in the face of intermittent rate hikes. And while Russian productivity is enjoying a smooth run, failure of monetary policy tools could just as easily backfire.
While political dissent or international sanctions remain futile, inflation is the prime enemy which could detract the Russian economy. For years Russia has faced a sharp decline in living standards, and despite commendable fiscal management of the Kremlin, such a steep rise in prices is an omen of a financial crisis. Moreover, the unemployment rates have dropped to record low levels. However, the labor shortage is emerging as another facet that could plausibly ignite the wage-price spiral. Further exacerbating the threat of inflation are the $9.6 billion pre-election giveaways orchestrated by President Putin to garner more support for his United Russia party. Such a tremendous demand pressure could presumably neutralize the aggressive tightening of the monetary policy by the RCB. Thus, while President Putin sure is on a definitive path of immortality on the throne of the Kremlin, surging inflation could mark a return of uncertainty, chip away investors’ confidence: eventually putting a brake on the economic streak.
Synchronicity in Economic Policy amid the Pandemic
Synchronicity is an ever present reality for those who have eyes to see. –Carl Jung
The Covid pandemic has elicited a number of deficiencies in the current global governance framework, most notably its weaknesses in mustering a coordinated response to the global economic downturn. A global economy is not fully “global” if it is devoid of the capability to conduct coordinated and effective responses to a global economic crisis. What may be needed is a more flexible governance structure in the world economy that is capable of exhibiting greater synchronicity in economic policies across countries and regions. Such a governance structure should accord greater weight to regional integration arrangements and their development institutions at the level of key G20 decisions concerning international economic policy coordination.
The need for greater synchronicity in the global economy arises across several trajectories:
· Greater synchronicity in the anti-crisis response across countries and regions – according to the IMF it is a coordinated response that renders economic stimulus more efficacious in countering the global downturn
· Synchronicity in the withdrawal of stimulus across the largest economies – absent such coordination the timing of policy normalization could be postponed with negative implications for macroeconomic stability
· Greater synchronicity in opening borders, lifting lockdowns and other policy measures related to responding to the pandemic: such synchronicity provides more scope for cross-country and cross-regional value-added chains to boost production
· Greater synchronicity in ensuring a recovery in migration and the movement of people across borders.
Of course such greater synchronicity in economic policy should not undermine the autonomy of national economic policy – it is rather about the capability of national and regional economies to exhibit greater coordination during downturns rather than a progression towards a uniform pattern of economic policy across countries. Synchronicity is not only about policy coordination per se, but also about creating the infrastructure that facilitates such joint actions. This includes the conclusion of digital accords/agreements that raise significantly the potential for economic policy coordination. Another area is the development of physical infrastructure, most notably in the transportation sphere. Such measures serve to improve regional and inter-regional connectivity and provide a firmer foundation for regional economic integration.
The paradox in which the world economy finds itself is that even as the current crisis is leading to fragmentation and isolationism there is a greater need for more policy coordination and synchronicity to overcome the economic downturn. This need for synchronicity may well increase in the future given the widening array of global risks such as risks to cyber-security as well as energy security and climate change. There is also the risk of the depletion of reserves to counter the Covid crisis that has been accompanied by a rise in debt levels across developed and developing economies. Also, the speed of the propagation of crisis impulses (that effectively increases with technological advances and globalization) is not matched by the capability of economic policy coordination and efficiency of anti-crisis policies.
There may be several modes of advancing greater synchronicity across borders in international relations. One possible option is a major superpower using its clout in a largely unipolar setting to facilitate greater policy coordination. Another possibility is for such coordination to be supported by global international institutions such as the UN, the WTO, Bretton Woods institutions, etc. Other options include coordination across the multiplicity of all countries of the global economy as well as across regional integration arrangements and institutions.
Attaining greater synchronicity across countries will necessitate changes in the global governance framework, which currently is characterized by weak multilateral institutions at the top level and a fragmented framework of governance at the level of countries. What may be needed is a greater scope accorded to regional integration arrangements that may facilitate greater coordination of synchronicity at the regional level as well as across regions. The advantage of providing greater weight to the regional institutions in dealing with global economic downturns emanates from their greater efficiency in coordinating an anti-crisis response at the regional level via investment/infrastructure projects as well as macroeconomic policy coordination. Regional development institutions also have a comparative advantage in leveraging regional interdependencies to promote economic recovery.
In conclusion, the global economy has arguably become more fragmented as a result of the Covid pandemic. The multiplicity of country models of dealing with the pandemic, the “vaccine competition”, the breaking up of global value chains and their nationalization and regionalization all point in the direction of greater localization and self-sufficiency. At the same time there is a need from greater synchronicity across countries particularly in the context of the current pandemic crisis. Regional integration arrangements and institutions could serve to facilitate such coordination in economic policy within and across the major regions of the world economy.
From our partner RIAC
A New Strategy for Ukraine
Authors: Anna Bjerde and Novoye Vremia
Four years ago, the World Bank prepared a multi-year strategy to support Ukraine’s development goals. This was a period of recovery from the economic crisis of 2014-2015, when GDP declined by a cumulative 16 percentage points, the banking sector collapsed, and poverty and other measures of insecurity spiked. Indeed, we noted at the time that Ukraine was at a turning point.
Four years later, despite daunting internal and external challenges, including an ongoing pandemic, Ukraine is a stronger country. It has proved more resilient to unpredictable challenges and is better positioned to achieve its long-term development vision. This increased capacity is first and foremost the result of the determination of the Ukrainian people.
The World Bank is proud to have joined the international community in supporting Ukraine during this period. I am here in Kyiv this week to launch a new program of assistance. In doing this, we look back to what worked and how to apply those lessons going forward. In Ukraine—as in many countries—the chief lesson is that development assistance is most effective when it supports policies and projects which the government and citizens really want.
This doesn’t mean only easy or even non-controversial measures; rather, it means we engage closely with government authorities, business, local leaders, and civil society to understand where policy reforms may be most effective in removing obstacles to growth and human development and where specific projects can be most successful in delivering social services, particularly to the poorest.
Looking back over the past four years in Ukraine, a few examples stand out. First, agricultural land reform. For the past two decades, Ukraine was one of the few countries in the world where farmers were not free to sell their land.
The prohibition on allowing farmers to leverage their most valuable asset contributed to underinvestment in one of Ukraine’s most important sources of growth, hurt individual landowners, led to high levels of rural unemployment and poverty, and undermined the country’s long-term competitiveness.
The determination by the President and the actions by the government to open the market on July 1 required courage. This was not an easy decision. Powerful and well-connected interests benefited from the status quo; but it was the right one for Ukrainian citizens.
A second area where we have been closely involved is governance, both with respect to public institutions and the rule of law, as well as the corporate governance of state-owned banks and enterprises. Poll after poll in Ukraine going back more than a decade revealed that strengthening public institutions and creating a level playing field for business was a top priority.
World Bank technical assistance and policy financing have supported measures to restore liability for illicit enrichment of public officials, to strengthen existing anticorruption agencies such as NABU and NACP, and to create new institutions, including the independent High-Anticorruption Court.
We are also working with government to ensure the integrity of state-owned enterprises. Our support to the government’s unbundling of Naftogaz is a good example; assistance in establishing supervisory boards in state-owned banks is another. We hope our early dialogue on modernizing the operations of Ukrzaliznytsia will be equally beneficial.
As we begin preparation of a new strategy, the issues which have guided our ongoing work—strengthening markets, stabilizing Ukraine’s fiscal and financial accounts; and providing inclusive social services more efficiently—remain as pressing today as they were in 2017. Indeed, the progress which has been achieved needs to continue to be supported as they frequently come under assault from powerful interests.
At the same time, recent years have highlighted emerging challenges where we hope to deepen and expand our engagement. First, COVID-19 has underscored the importance of our long partnership in health reform and strengthening social protection programs.
The changes to the provision of health care in Ukraine over recent years has helped mitigate the effects of COVID-19 and will continue to make Ukrainians healthier. Government efforts to better target social spending to the poor has also made a difference. We look forward to continuing our support in both areas, including over the near term through further support to purchase COVID-19 vaccines.
Looking ahead, the challenge confronting us all is climate change. Here again, our dialogue with the government has positioned us to help, including to achieve Ukraine’s ambitious commitment to reduce carbon emissions. During President Zelenskyy’s visit to Washington in early September we discussed operations to strengthen the electricity sector; a program to transition from coal power to renewables; municipal energy efficiency investments; and how to tap into Ukraine’s unique capacity to produce and store hydrogen energy. This is a bold agenda, but one that can be realized.
I have been gratified by my visit to Kyiv to see first-hand what has been achieved in recent years. I look forward to our partnership with Ukraine to help realize this courageous vision of the future.
Originally published in Ukrainian language in Novoye Vremia, via World Bank
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