What’s behind global inflation and where are we headed?

The year 1996 saw the publication of Roger Bootle’s provocatively titled book The Death of Inflation, which argued that inflation was no more the threat it used to be and fixation with keeping prices low can hamper growth unnecessarily. The book is a compelling read. Yet, the challenges brought about by the pandemic may be in conflict with the optimism in it, as reflected in Bootle’s own columns and interview.

COVID19 did not just catch the global health infrastructure off guard, but wreaked havoc on the world economy as well, particularly in terms of ushering in an era of intractable inflation. Here’s a look at how the infection jumped from person to person, eventually subduing the economy, and throwing demand and supply into a nagging imbalance.

The demand side: The virus and the price of your groceries

Faced with sudden outbreaks, panicking governments the world over were left with no choice but to swallow the bitter pill of lockdowns. It was clear that there was no alternative, at least in the short run. The policy helped control the contagion, but not without business closures and job losses. This, in turn, raised a natural question: how to help the common person muddle through the crisis with the economy at a standstill?

Almost all economists favored economic stimulus—financial help from the government channelled through the fiscal and/or monetary policies—but answers to how, how much, when, and where varied drastically.

Most governments around the world offered one kind of stimulus or another. Yet some countries with the highest stimuli—say, Canada, Germany, Spain, or the United Kingdom—are now experiencing record inflation.

Inflation in the United States, the country with perhaps the largest stimulus packages, has hit a 40-year high, with prices this March being 8.5% higher than March last year. This has meant the average household having to spend nearly $327 more per month than they used to, a year ago.

After all, if one gets up one fine morning and finds a serendipitous check at their doorstep, which literally happened in the U.S., sooner or later, they are going to go shopping, i.e., demand increases. But the neighborhood grocer has limited items, i.e., supply remains the same. More people running after scarce goods made the prices rise, as it does. This effect was worse in service industries, where some businesses even had to pack up.

Arguably, the stimulus packages, while helping the economies recover, perhaps also created conditions for high inflation by encouraging consumption. While stimuli may be more conspicuous in the advanced economies, almost all economies offered some kind of stimulus, swelling their fiscal deficits, as governments increased spending to make up for the fall in economic activity.

The supply side: The rising costs of production

Yet, to fault the economic stimulus for inflation would be somewhat simplistic. Many economists expected such inflation to be transitory—short-lived—after all. Transitory, it could have been, if it hadn’t been for the surge in the price of oil.

Note that COVID19 had initially caused inflation because of the sky-rocketing costs of shipping, supply chain disruptions, erratic demand, and international business desynchronization due to asynchronous outbreaks. Economic activity had plummeted, sending oil demand—and its price—into a free fall.

One of the reasons the oil price fell is that oil supply is relatively “inelastic” in the short run. That is to say, oil companies cannot cut down on oil production suddenly. These are giant enterprises with fixed, long-term costs. As demand vanished due to the virus—and supply could not suddenly be scaled back immediately—oil flushed markets, and oil price fell drastically.

This should have made everything cheaper. But as economies recovered, often with a sharp, V-shaped recovery, thanks to the vaccines, the demand for oil rebounded phenomenally. So much so that even though the world economy still has not fully recovered from the pandemic, oil demand may have already surpassed its pre-pandemic levels.

The resurgence in oil demand—with limited supply available—made the prices skyrocket, from a record low of minus $40 per barrel at the start of the pandemic to around $120 per barrel now.

Yet of course, this rise is not without the added conundrum of Putin’s war on Ukraine. Supply disruptions due to the war, with the added effect of sanctions, and now an embargo, have worsened the spike in energy, both oil and gas, prices, given the fact that Russia is among the top three producers of crude oil, and the second largest producer of natural gas in the world.

In addition, uncertainty brought by the war has affected investment and financial markets the world over. Stock markets have been bearish. Businesses are having to look for alternative trading partners. These factors, along with higher oil prices, are making costs of businesses soar, leading to “cost-push inflation”—higher prices arising from higher costs of production.

The outlook is not good as yet

Together, resurgence in demand after quick initial recovery, and a fall in global supply due to higher costs of production, have translated into an indomitable surge in prices the world over. Turkey has seen prices rise by 70% between April 2022 and April last year.

The corresponding figure for Argentina stands at 58%, and for Venezuela, Sudan, and Lebanon, at over 200%. While inflation in these countries may not be attributable exclusively to the above stated factors, as these economies were already stuck in macroeconomic blues—sometimes trying their luck with unorthodox policies—the pandemic and war have complicated things considerably. Even in advanced economies, the IMF estimates a 38-year high record inflation for the current year.

Average incomes, in turn, will grow only modestly this year, as reflected in the world GDP forecasts being revised over and over again. While growth in the oil-exporting Gulf economies forms an exception, as they are benefiting from higher energy prices, even those will not be immune to food inflation, considering 85% of their food comes from imports.

But the outlook for the developing economies is particularly concerning. They are facing capital flight as investors opt for higher return in the advanced economies, where interest rates are rising, pushing the indebted countries closer to default. This will further pressure stressed currencies, worsening inflation, with more countries having to knock the IMF’s door, sooner or later. Calls for international financial institutions to take a more helpful role to help the distressed countries are, understandably, increasing.

Likewise, devising a careful policy at the national level may be crucial to people’s livelihoods. It may be argued that governments need to prioritize fighting inflation over showcasing economic growth. A blind pursuit of growth would lead to higher demand and translate almost inevitably into more inflation.

As for the micro level of managing a household, it may be just prudent to adapt our spending patterns to the disheartening reality of deep-seated inflation, and perhaps spare a few bucks to help those in distress. Inflation isn’t dead, as yet. But the world needs a healing touch, now perhaps, more than ever.

(Published first on Politics Today, June 6, 2022)

‘Else equal, a dismal economist at the helm is better for an economy than a smart CEO

THOMAS Carlyle, in his essay Occasional Discourse on the Negro Question, argued that the idea of abolition of slavery was incompatible with high productivity. It was in this essay that he referred to economics as an abject, distressing, and a dismal science; a reference clichéd since.

One may differ over the dismal nature of economics, not least because of Carlyle’s bizarre, racist arguments. But, economists, to be honest, are somewhat distressing and dismal. You can tell if you’ve actually met one. Imagine a CEO on the other hand, and spontaneously the image of a dynamic, enterprising individual with a healthy risk appetite comes to mind.

No prizes for guessing that Imran Khan himself is more of the latter kind. Whether it in cricket and welfare previously, or is in his position as prime minister now, he prefers leaps of faith over prudence. Naturally, he can relate with the grittier CEO kind better.

Of course, Dr Abdul Hafeez Sheikh was the dismal kind — a somewhat paternalistic economist. One may visualise Dr Sheikh telling a restless Khan Sahib week after week that there was no route to his much-promised land in the immediate future with an irritating consistency, worsened by a stoic face.

On the other hand, Shaukat Tarin, like Asad Umer, is the enterprising kind. How could such corporate giants, with their verve and experience, have failed in economic management?

Indeed, the monetary side of the economy is a somewhat obscure world that lies behind the simpler fiscal side. A policy that is good for raising taxes and building infrastructure — the fiscal side — may lead to higher prices for the common person — a monetary effect — which adversely affects people’s standard of living.

Much like a greenhouse, which otherwise is meant to keep plants warm, can get overheated with the entrapment of too much heat and light, economists say the economy is ‘overheated’ if there is too much inflation. If fiscal policy is like sowing seeds in a greenhouse, the monetary policy is about maintaining its temperature.

According to conventional economic wisdom, you can’t outgrow inflation. That is, a government’s effort to spend more to achieve a higher GDP growth is doomed to failure in times of already high inflation. The government may hope to achieve prosperity with industrial growth, but a stimulus to the economy — say, incentives to spur investment — will almost certainly lead to even higher inflation. And the inflation, unfortunately, comes before the fruit of policy on the fiscal side ie before growth.

The central bank advises policymakers in such circumstances that they’re going to burn the plants in their frantic desire for faster growth. A higher policy rate is one of the bitter pills central banks have to cool the economy, much like opening the windows of a greenhouse.

When Tarin was brought in, the economy was recovering. Government was boasting about the growth it had achieved the previous year (ironically under the Sheikh-Reza Baqir duo). But inflation was still on an upward trajectory. It still needed time to be tamed. In fact, it was suggested that Tarin had been brought in to control inflation.

But Tarin, gauging his boss’s pulse, aimed at instant growth, which was a recipe for worsening inflation. He spared no opportunity to criticise the State Bank for maintaining a ‘high interest rate’, which in his view, had been hurting growth as well as the parity of the rupee somehow. Thus, with much fanfare, Tarin presented a growth budget.

This clearly pressured the State Bank and it tried to accommodate the government’s growth stance, not raising the interest rate for 15 months. With a low interest rate and lesser spreads, the short-term foreign in­­vestors have an incentive to pull their (controversial, hot) money out of the economy. Deprecia­tion in turn affects even the longer-term investors, worsened by a rising current account deficit (even higher without the serendipitous remittances) and higher energy prices, which put downward pressure on the currency.

Now, undergoing a change of heart, Tarin Sahib favoured a higher interest rate in an interview and hoped, the State Bank had learned from high inflation and the rupee’s depreciation. Thus, faced with raging inflation, his enthusiasm for lower interest rates and higher growth, his rallying cry a few months back, has all but disappeared. One really wonders who actually needs to learn what.

What, nevertheless, clear is that because businesses don’t have a parallel, elusive monetary side, even the smartest people from the corporate world have a hard time appreciating that investing can indeed be counterproductive for an economy, for example, when overheated. Economists, for their part, can be thick in their own way, a subject for another day. Yet, sometimes an economy in need just needs an economist, even if a dismal one.

(Published in Dawn, December 25th, 2021)

Understanding Policy Rate

LET’S say, I am a fruit vendor, and the only one in the village. There is only one kilogramme of apples left in my shop. I am about to go home. A person comes to my shop and I sell the apples for Rs100.

The next day something weird happens. A smuggler’s briefcase splits open, and money starts dropping to the ground from his plane all over the village. It’s evening again, and again I am left with just 1kg — but today, there are many buyers. I sell the apples for Rs200.

Here, apples are the total production. The money that the buyer had in the first instance, Rs100, is the money supply. When you increase the money supply — notes falling from the plane — it leads to higher prices, because of higher demand. Economists call this inflation. Note that the total number of apples — GDP or production — does not increase.

One of the better known instruments for dropping money from the plane is lowering the policy rate. Simply put, it is the benchmark rate set by the central bank at which loans would be given. When this is lower, the commercial banks also charge a lower rate for lending.

Thus, if you wanted to buy a bike, but the bank was charging an interest rate of 20 per cent. You might have been dismayed. But then the benchmark — policy — rate falls to, say, 2pc. You rush to the bank and borrow money to get the bike.

But here is the catch. When you reach the bike company, they tell you that the price of the bike has increased significantly. You ask why. They tell you there are so many people who want a bike now, and they have limited bikes. The prices go up.

Thus, a fall in policy rate leads to increased prices. It does notmake people richer. People have more money, but the goods became more expensive too.

Governments, businesses, and the ‘more patriotic’ economists, almost always support a lower policy rate. They want ‘indigenous’ growth, instead of borrowing from external sources or relying on foreign investment.

Lowering the policy rate can indeed lead to growth in the short run, as they argue. If the economy is in recession, there is idle capacity in the factories. When you lower the policy rate, not only does the demand increase, but also the production. The factories will utilise their idle capacity and make more bikes to catch up with the increased demand. More people want bikes, but there are also more bikes now. Welfare increases.

But in an overheated economy, with high consumption and inflation, and no idle capacity in the factories, the opposite is true. Lowering the policy rate, does not result in more production — as factories are working to their maximum potential already — it results in greater inflation. Having more money, more people want a bike, but the factories have already reached their limit.

Thus, the economic activity generated by the lower policy rate may be illusory, translating to higher inflation, rather than higher production. Perhaps all spells of hyperinflation in history began because governments myopically kept raising the money supply in the hope of more and more growth.

Also, demand-side decisions are simpler. A lower policy rate almost automatically leads to increased demand. But supply-side decisions are complex. Investors and businesses will likely not invest in a bad policy environment or during hard times such as a pandemic. Thus, a lower policy rate may translate into more demand but not a higher aggregate supply.

The point here is not to advocate a higher or a lower policy rate, but to advise caution. Beware of a person — an economist, a journalist or business tycoon — who comes on television to declare an exact figure for the policy rate off the cuff.

The State Bank did a decent job in stabilising the economy, res­toring confidence, stea­d­ying the rupee, and bringing down core inflation. Had Covid-19 not struck, the budget for fiscal year 2020-2021 would have been expansionary. The PTI could well have showcased growth.

But things did not go as planned, and the government wanted to do something rather quick. The high food inflation right now is perhaps a consequence of the authorities taking the sugar millers, flour millers, the middlemen, the retailers, and many other groups head-on without doing their homework. In essence, it is an issue of governance, and again the State Bank cannot be blamed for not being able to dent inflation. It brought core inflation down significantly.

In short, the State Bank raised the policy rate when the economy was overheated and prices were soaring. It brought it down to support the economy when the pandemic struck. But determining the optimal policy rate is a complex decision. It involves intricate models, simulations, and calculations, even if with some judgement. That is what the State Bank is there for. Let it work.

(First published in Dawn, here).