Commentary: Inflation will get worse before it gets better
How long inflation will persist is being intensely debated, but the factors at play aren’t just the Ukraine war and zero-COVID lockdowns in China, says NUS Business School’s Cai Daolu.
SINGAPORE: Inflation is knocking at everyone’s door. Singapore’s core inflation rate was at a 10-year high of 2.9 per cent year-on-year in March.
Surging core inflation requires us to be vigilant. It may mean that higher prices might not go away so soon.
Core inflation gives us a sense of the trajectory of prices in the long run. That’s because it doesn’t include historically volatile categories such as food and energy, which react to supply shocks like the weather and wars, but are ultimately temporary.
And with major economies including the United States and Europe reporting historically high inflation rates in recent quarters, it looks like the pandemic-battered global economy must find one more fight in it before it can recover.
The Monetary Authority of Singapore (MAS) and the Ministry of Trade and Industry said in April that external inflationary pressures have intensified amid “sharp increases in global commodity prices and renewed supply chain disruptions driven by both the Russia‐Ukraine conflict and the regional pandemic situation”.
But MAS has also said that core inflation is forecast to pick up further in the coming months before moderating towards the end of the year.
How long inflation will persist is being intensely debated by economists around the world. Some inflationary pressures are expected to recede, but how soon they do depends on how persistent the external shocks are.
THE 'TEMPORARY' SHOCKS OF WAR
For one, the Ukraine war is already into its eleventh week and no one can say for sure how long more it may drag on. Both Russia and Ukraine are major exporters of many commodities and are the world’s largest exporters of wheat and sunflower oil respectively.
Economic sanctions against Russia mean they have fewer buyers for their goods, especially Russian oil which has been the target of boycotts. Fuel shortages and port blockades are also making it hard for Ukrainian farmers to move exports.
The energy and agricultural sectors across the world are severely affected. Exporters besides Russia and Ukraine are now price setters, but consumers tend to respond to higher prices by reducing consumption, easing off some demand.
History shows that price surges in food and energy induced by short-term shocks are often reversed. For example, a 2011 drought in the US caused international prices of food to reach historical highs, before dropping back to pre-crisis levels in the following years.
The displacement of people and the destruction of infrastructure may hurt for years, if Ukraine can only plant a fraction of its normal crop such that it becomes hard to fulfil global food demand.
On the other side of the world, zero-COVID lockdowns in China have amplified the global prices of goods and services. In April, China’s manufacturing activity fell to its lowest level in more than two years. This blow to the manufacturing powerhouse creates further stress for global supply chains – goods cost more to manufacture and deliver while everyone’s wallet is shrunk by inflation.
But even China’s zero-COVID is expected to ease off eventually. The economic toll of locking down major hubs like Shanghai and Shenzhen, possibly even Beijing, cannot be infinitely absorbed. Forecasts for China’s GDP growth have already been cut.
Meanwhile, firms will find alternatives to get around supply bottlenecks. Singapore Minister of State for Trade and Industry Low Yen Ling said in Parliament on May 9 that while China’s lockdowns have delayed some imports in the manufacturing and construction sectors, firms have largely been able to cope.
The inflationary pressure of war and supply constraints won’t fully recede in the short and medium run, but will have a heterogeneous effect on different industries.
THE LONG-TERM EXTERNAL FACTORS
The excessively lax monetary and fiscal policies in major economies, like the US, during the pandemic have been pernicious. Major central banks and governments had little choice but to enact policies to mitigate the economic impact of a global public health crisis. But the results have come back to haunt them.
The US government had issued an additional US$3 trillion debt to fight the pandemic. This amount was mostly absorbed by the Federal Reserve. While the aid has mostly stopped, consumption is also picking up in the post-pandemic recovery.
The pressure here is more long-term because it is about the sustainability of the fiscal position of the governments of many developed countries. Increasing debt means countries also have the option of printing money to serve this fiscal obligation. The value of money will erode and result in more inflation.
Before the pandemic, the US government debt was about as much as the country’s annual gross domestic product. Today, it is around 140 per cent of annual output.
The annual inflation rate in the US was 8.5 per cent in March 2022, the highest since December 1981. How much of this inflation is caused by these lax policies, as opposed to the disruption of the supply chain and geopolitical tensions, remains an essential question for policymakers.
Investors are looking to see if the US government will be able to generate enough fiscal surplus to serve these debts. If it doesn’t, the US Federal Reserve would have to assume more debt – something that goes against its current efforts to sell bonds and decrease the money supply. More debt will hurt the purchasing power of the US dollar.
Meaningful structural fiscal reforms are needed in countries like the US. But urging austerity, politically speaking, is often a difficult message. The Fed has already announced it will hike interest rates seven times in 2022, to achieve an inflation rate of 2 per cent.
AN APPRECIATING SINGAPORE DOLLAR TO EASE PRICE SURGES
In Singapore, the MAS has also tightened monetary policy by allowing the Singapore dollar to appreciate against a bundle of foreign currencies. The logic is straightforward: A stronger Singapore dollar means that we pay less for things on the international market with a more favourable exchange rate.
The impact of increasing international prices will be absorbed by the appreciating Singapore dollar, instead of being transmitted into local prices. So for many households, this will help absorb some of the rising prices.
But a stronger Singapore dollar also means our exports will be relatively more expensive. This may make it harder for businesses to stay competitive in the global market. Thus, any further changes to our monetary policy need to be carefully calibrated.
LOOMING THREAT OF STAGFLATION
The economic paths for both developed and developing countries have been tumultuous since the pandemic hit us. And within a matter of weeks, the global economy has been hit with a wave of severe shocks that can delay a full recovery for many nations.
The current environment of high global inflation and surging commodity prices may bring us back to a similar situation in the 1970s. Back then, the oil crisis fuelled a severe supply shock, and policymakers accommodated the supply shock by increasing aggregate demand.
This combination of factors had caused the episode of “stagflation” – a prolonged period of low GDP growth, high inflation and rising unemployment.
The world is undoubtedly dismayed that after two years of grappling with COVID-19, we haven’t been able to go back to the seemingly more carefree pre-pandemic days.
There’s no perfect way to control this episode of inflation, but there’ll be a lot of careful adjustments to stabilise external shocks, maintain price stability, promote robust growth and hopefully, keep the more dire threat of stagflation away.
Cai Daolu is a Visiting Senior Fellow at the NUS Business School’s Department of Strategy and Policy.