Since the re-opening of the global economy, inflation has been rising around the world. This sudden change of macroeconomic conditions caught policymakers off-guard in terms of updating inflation forecasting models to a fast-evolving scenario as well as assessing the causes of this sudden surge and, remarkably, whether such causes are transitory or permanent.
Considering the facts. Figure above shows the monthly time series of 12-month CPI inflation rates across three large countries: the US, the UK, and Germany. Emphasizing three macro-periods: (1) the pre-COVID-19 era, categorized by low and stable inflation rates globally; (2) the COVID-19 era, when large parts of the global economy were artificially shut down and consumer prices declined; and (3) the post-COVID-19 era, when inflation surged and reached levels unseen for decades.
However, to assess the magnitude of this rise, note that in the US the average inflation rate in September and October 2021, at 5.6%, was almost three times higher than the average inflation rate in the six months before the COVID-19 crisis hit.
Despite the rapid surge, this increase in inflation was hardly unexpected. Because of the strict lockdown policies and COVID-19 closures across the globe, both the supply and demand of goods and services suddenly dropped to zero – perhaps for the first time in human history. While production stopped, many consumers started to accumulate savings as they did not face income cuts and had fewer opportunities to spend. In many countries, the surge in savings was also fueled by generous fiscal support through various fiscal policy measures.
Once the global economy reopened, as would happen with any car whose engine was shut down for months in the cold weather, production activities and supply chains needed time to restart: many workers had reallocated to different jobs, machinery was obsolete, and so on. In contrast, consumers immediately jumped at newly available spending opportunities, thus putting substantial demand pressure on a supply side that was already stressed. It is thus unsurprising that a slowly adjusting supply and fast-growing demand determined supply bottlenecks, backlogs in orders, and ultimately a sharp rise in prices.
In addition to demand pressures and supply-chain disruptions, labor market pressures were a third factor: with a substantial share of the working population retiring early after months of inactivity and other groups having enough liquidity to search for better employment matched, absenteeism and manpower constraints put additional pressure on the recovery and restart of productive activities worldwide.
Moreover, we have observed for the first time in decades substantial wage increases. Initially, wage increases were concentrated in the lower parts of the income distribution, but towards the end of 2021 noticeable increases reached the middle of the distribution, too. Large firms announced that they budgeted average wage increases of around 4% for 2022.
Similarly, higher wages imply higher marginal costs for firms. And the shortage of raw materials and increasing energy prices put additional upward pressure on firms’ costs of production.
Based on this assessment of the causes of the post-COVID-19 surge in inflation, it can be concluded, alongside the ECB, that such causes are likely to be temporary and resolve in the medium run (18 months to 2 years) as supply activities adjust. If so, no monetary policy actions would be needed because inflation would turn back to its long-term target in the medium run.
From the perspective of Pakistan, there comes the issue of increase in the prices of fuel, devaluation of currency and on top poor law and order. Let’s say if a commodity’s price increases 1% by the corruption from middle man, or other sales people it reaches to the end consumer with the further increase of 5% or more.
However, Government of Pakistan under the leadership of Prime Minster Imran Khan is taking careful steps in order to curtail this menace. Prime Minister’s policy for boosting the agriculture, enhancement in travel and tourism,growing the exports and to provide maximum benefits and privileges to the business community and private sector will improve the economy circulation, moreover will aid in decreasing the inflation factors.