Why is inflation high and will it show no change?

Inflation is rising and the prospect of a cost of living crisis looms for many people across the world, particularly due to the food and energy costs in the wake of the COVID-19 pandemic, and the Russian-Ukrainian war.

The monthly food price index from the Food and Agriculture Organization (FAO), which tracks prices of globally-traded food commodities, reported an increase of 12.6% between February and March to hit the highest level since its inception in 1990.

The FAO’s cereal price index rose by an even greater amount – 17.9% – over the period, reflecting a surge in global prices of wheat and coarse grains, largely due to export disruptions from Ukraine, one of the world’s largest wheat exporters.

Where is today’s inflation coming from?

Chief Economist Paul Donovan, described the current spike in inflation as “historical”, adding that it will not last at these levels for much longer.

Donovan ascribed the reason behind inflation spike to the extraordinary demand for goods in 2021 as countries emerged from lockdowns, shops opened and people were able to go out and buy stuff with money saved during weeks of economic inactivity.

Demand and supply

Inflation was caused by an extraordinary surge in supply of goods.

When demand is greater than supply, this will result in either shortages or price increases, Donovan explained, adding that the world saw the mixture of both.

Now, demand started to fade because by the end of last year in a number of countries, consumers’ stock of savings had disappeared so the demand was coming down.

Consequences of the war

The demand-driven inflation was starting to fade, until the war in Ukraine wreaked economic havoc.

Each of Russian and Ukraine export important commodities, including oil and wheat. Accordingly, this war impacted those exports.

This has led to higher commodity prices, partly because there have been constraints on supply. The result of this increase in commodity prices has fed through to inflation.

The price of a barrel of crude oil has consequences for things like food, airfares, petrol etc – because all of these are reliant on fuel.

Has inflation peaked?

When asked whether inflation has peaked, Donovan said the answer depends where you are. Inflation probably peaked in the US last March. In the UK, it’ll be a little later and in Europe, it’ll be later still.

Overall, inflation is expected to tame in the second half of the year, the economist said, adding that this decline will be driven by lower demand for more commodities, which will lead to a decline in prices and reduce inflation.

The best things governments can do is nothing, as they really cannot change the oil price.

Central bankers cannot also suddenly change the price of wheat and other commodities, Donovan noted.

Part of the pricing inflation story is already naturally coming down, and other factors like the impact of the Ukraine war on food and fuel prices are beyond the scope of influence from most governments, he adds.

Over the next 10 years, governments of course can encourage investment in renewable energy and so on. But in the short term, there is a limit to what governments can do to offset price increases.

Source: WEF