Sanisha Packirisamy, Economist at Momentum Investments
“Inflation is as violent as a mugger, as frightening as an armed robber, and as deadly as a hit man.” These words, spoken by Ronald Reagan during his presidency, resonate with the severity of the inflation problem that plagued the United States in the early 1980s.
The narrative of inflation traces back to the inception of money itself. When inflation spirals out of control, its repercussions on an economy can be profound. Unrestrained price escalations erode buying power, diminish corporate competitiveness and widen the gap between the rich and the poor.
For decades, mature economies across the world had managed to keep the inflation genie securely locked away. However, recent events, including the COVID-19 pandemic and the conflict in Ukraine, reignited fears of inflation. The most commonly cited factors driving the recent upswing in inflation were high food and energy costs. These prices soared after Russia’s invasion of Ukraine, disrupting global supply chains and squeezing family budgets worldwide.
Despite a retreat in inflation concerns from their peak, global worries about price pressures persist, as inflation continues to exceed targets in most economies worldwide. This is hardly surprising when one considers renowned economist Milton Friedman’s theory that changes in monetary policy affect the economy with long and variable lags. Authorities responded to the dampening economic effects of pandemic lockdowns with substantial interest rate cuts and asset purchases, alongside ample fiscal stimulus to support households and businesses. Assuming a lag of between 12 and 24 months, these monetary policy changes would have had more powerful effects on raising inflation during 2022 and 2023.
The global inflation landscape
Factors driving the sustained rise in prices have varied across economies. In Europe, energy price shocks due to the region’s dependence on Russian energy imports have had a cascading effect on connected industries by impacting the cost of supply chain inputs. In the United States, tightness in the labour market has driven second-round inflation, prompting demands for wage growth to match rising living costs.
The global inflation landscape exhibited a broadening disparity in inflation rates during the 2022 surge, tilting towards an upward skew. However, this trend has since started to normalise with tamer inflation in services and wages. Part of the deceleration in inflation can also be attributed to the implementation of more restrictive monetary policies necessary to curb price pressures. This tightening is beginning to have an impact, with restrictions in credit availability placing a burden on housing markets, investment and overall economic activity.
The International Monetary Fund predicts a steady decline in global headline inflation, but it is not expected to return to target until 2025 in most cases. The pace of expected disinflation is likely to be more pronounced for advanced nations due to stronger monetary policy frameworks and central bank communication as well as lower exposure to commodity price changes and exchange rates.
Despite resolute actions taken by global central banks and the likelihood they are nearing the peak of their previously synchronised tightening cycles, inflation continues to surpass targets in nearly all economies with an inflation target. As such, cutting interest rates too soon could squander the gains by monetary policy tightening in the past two years. Adding to the challenge, recent market unease regarding an escalation of conflict in the Middle East has further constrained supply in international oil markets, presenting an upside risk to inflation.
How do we bottle the inflation genie?
Closer to home, the South African Reserve Bank (SARB) maintains a firm resolve to get the inflation genie back into the bottle and keep it there. The SARB has maintained a tight stance on monetary policy despite a slowing in economic activity to address the persistence of upside risks to inflation. On numerous occasions the bank has emphasised the dangers of too-high inflation, especially for the less privileged, whether stemming from domestic demand, power disruptions or external shocks beyond the country’s control. As such, even during an economic slowdown, the bank is obliged to tackle second-round inflationary effects and mitigate a rise in inflation expectations, while prioritising long-term economic stability.
As with global central banks, the future path of policy rates and the timing of the first interest rate cut in SA will hinge on whether monetary authorities feel confident enough that disinflation is progressing in line with expectations. In other words, whether inflation will subside to 4.5% on a more sustainable basis in the coming quarters.
So how do we bottle the inflation genie once it’s out? The solution, we believe, lies in a multifaceted approach involving monetary policy, fiscal interventions, enhanced data analysis, efficient supply chain management, promoting competition, matching pay with productivity and shaping forward-looking inflation expectations. Policymakers today grapple with the same inflationary challenge that Reagan faced during his presidency. The battle against inflation is ongoing and it requires a forward-looking approach to ensure that the inflation genie remains securely contained to protect the economic well-being of nations.