“Low inflation is indeed the problem of this time.” That said John Williams, President of the Federal Reserve Bank of New York, in late 2019, echoing the prevailing view at the time. Fast forward to the present, and the problem is just the opposite. Almost every country in the world has to contend with rising prices in 2022. The situation will almost certainly improve in the coming year, but at a significant cost to economic growth.
What made 2022 so unusual was the breadth of price pressure. The global inflation rate will end the year at around 9%. For many developing countries, high inflation is a recurring challenge. But the last time inflation was this high in rich countries was in the early 1980s. In America Consumer prices are expected to have risen by around 7% by 2022, the highest in four decades. In Germany, the rate will be closer to 10%, the first bout of double-digit inflation since 1951.
The common factors driving inflation everywhere were rising fuel and food costs. Prices for many consumer goods were already trending upwards in early 2022 due to the ongoing impact of Covid-19 on supply chains. Russia’s invasion of Ukraine in February proved even more disruptive. Oil prices rose by a third as Western countries imposed sanctions on Russia, a major crude oil producer. Food prices also rose, spurred by fertilizer and transportation costs, as well as Russia’s blocking of grain exports from Ukraine, a major wheat producer. Economically, this was tantamount to a classic supply shock. The sudden increase in the prices of important raw materials quickly penetrated the everyday lives of world citizens. In Europe, which has long depended on Russian gas, millions will struggle to afford heating this winter. Across all regions, food and fuel accounted for more than half of inflation on average in 2022 (see chart).
If inflation were just a supply-side phenomenon, it would have been painful enough. The most worrying development for central bankers, however, was that pressure was seeping into “core” components of price indices – that is, goods and services other than volatile food and energy. The rise in core prices was an indication that inflation was picking up steam. This in turn pointed to causes beyond the oil shock. Many countries now have extremely tight labor markets, partly a result of a wave of early retirements during Covid. As a result, companies are paying higher wages to attract workers, adding to the inflationary dynamics. In America, where the rise in core inflation was particularly sharp, another culprit was excessive stimulus – from both the government and the Fed – at the height of the Covid-19 pandemic. For much of 2022, this led to overheated demand, with real personal spending higher than the pre-pandemic trend. Significantly, China was the major economy with the lowest inflation. Its “zero Covid” strategy pushed spending well below pre-pandemic trends.
There was a fear almost everywhere that rising prices would reset people’s inflationary expectations and prompt them to demand higher wages. Such dynamics, known as the wage-price spiral, would make eradicating inflation much more difficult. The mere threat of momentum was enough to prompt central banks to act. The Fed has been the most aggressive, raising interest rates from a zero floor in March to over 4% today, the sharpest dose of monetary tightening in four decades. Central banks all over the rich world, from Stockholm to Sydney, followed suit.
One way to look at the inflation outlook for 2023 is a duel between recovering supply and falling demand. Promisingly, some of the factors that fueled inflation in early 2022 have started to ease. Consumer goods prices have fallen as supply chains have returned to normal. Oil costs have fallen back to where they were a year ago, thanks in part to a recovery in production. Tighter monetary policy works by curbing demand, and that is beginning to happen. The most interest-rate-sensitive sectors are suffering the most: a sudden slowdown has settled over the once-sizzling real estate markets and transactions are drying up. If the recovery in supply – including, crucially, willing labor – is large and fast enough, central banks may be able to halt tightening before they trigger a deep recession. But as of this writing, it seems more likely that they will take a real toll on the global economy. In 2023, fears of inflation could give way to concerns about unemployment. ■
