Inflation, stagflation, recession

Years of neoliberal assault globally leading to a diminishing role of government, especially in regulating markets, do not allow proper measures being taken to avoid the Covid from becoming a pandemic in terms of a well-prepared public health sector, interventions in effectively dealing with climate change (a causal factor of the pandemic), and in reaching a vaccine.

This is because the first episode of the virus first appeared in SARS (severe acute respiratory syndrome) around two decades ago, and kept reappearing, for instance, a decade later in 2012 in the shape of MERS (Middle East Respiratory Syndrome) epidemic, and still the world was so ill-prepared when coronavirus became a pandemic.

On the other hand, as the pandemic unfolded, an environment of virtually unfettered markets, and a private sector strongly characterised by a profit mindedness, could not deal with the shocks on both the health and economic sides.

For instance, the idea of small government and procyclical/austerity stance had been taking roots for years in policy thinking generally, under the overall neoliberal assault. This thinking did not allow quick and adequate release of stimulus for the affected portions in developing countries, both in terms of direct financing, and provision of effective debt relief; given policy emphasis unrealistically remained on relying on domestic resource mobilization, even in an overall environment of recession-causing pandemic.

Not only that, more than the demand/supply dynamics, global supply chain crisis reflected a significant role of ‘profit-over-people’ mind-set, creating artificial bottlenecks, and charging inappropriately for services. This resulted in a level of inflation not seen in decades in both the developed and developing countries. This also meant that absolute poverty also took an upward turn for the first time in decades.

Over two years into the pandemic, lack of debt relief and provision of pledged climate finance, sub-optimal distribution of SDR allocation, practice of vaccine apartheid, unjustified use of IPRs to block needed level of knowledge-sharing and production of vaccine, rich, advanced countries, and multilateral institutions, have left a lot to be asked in terms of needed focus to deal with the underlying neoliberal mind-set. In other words, they exhibited a lack of global spirit.

Hence, after making so many serious mistakes, it is now of utmost importance that both central banks of major economies in particular and multilateral institutions like the International Monetary Fund (IMF) see inflation for what it is, and which is both a demand-side and supply-side phenomenon.

Here, it also needs to be understood that inflation as a supply-side phenomenon is a more dominant determinant in developing countries due to their relatively lack of financialization traditionally, and their greater reliance on imports of essential commodities like oil, food, machinery, etc. means greater role of imported/cost-push channel inflation in the wake of global supply chain crisis.

The significant extent of supply-side nature could be seen from the fact that with the war in Ukraine likely to go on for a number of months, and the lack of investment in green energy and in expanding oil supply capacity over the years, in addition to artificial supply shortages overall being created by the OPEC over for price gains, inflationary pressures in both developed and developing countries to remain well entrenched in the near term at least.

In a recent Bloomberg interview, chief oil analyst of ‘Energy Aspects’ highlighted a rather sticky high oil price outlook even as oil demand diminishes due to possible recession for the near term in the following words: ‘…even in a pretty deep recession, I just don’t see oil prices going below $80 [a barrel], may be not even $90 [a barrel] because of years of under investment [in the oil sector].’ For net oil importers like Pakistan, this could mean difficult consequences in terms of significant role played by imported inflation in already very high inflationary numbers.

Hence, there is a need that the policy of monetary contraction is balanced with meaningful supply-side interventions, and for this the neoliberal policy mind-set is also revisited to shift away from pro-cyclical/austerity mind-set on one hand, and well-spirited globalization and multilateralism on the other. The same should also be reflected in debt relief, SDR allocation/relocation, climate finance, and in IMF programmes, and in trade relations and much more cautious liberalization.

Central banks also need to internalize the multi-dimensional emphasis of inflation, and reflect its contractionary stance accordingly, given over-emphasis can exacerbate the stagflationary and recessionary impacts, which are already being felt in many developing countries – the case of Pakistan, for instance, serious stagflationary consequences are building up at the back of high inflation and over-board pro-cyclical policies, including an unjustifiably high interest rate – and where the likelihood of recession rising even in coming months in global North.

In this regard, a recent Financial Times (FT) published article ‘Central banks should keep their cool on inflation’ highlighted that there is need for central banks to rein in their tight monetary policy stance, given demand has not picked up much over the pre-pandemic levels, and there is a strong supply-channel active.

The writer, Martin Sandbu, argued, among other things, that ‘Central bankers take no pleasure in this, of course. Their case relies on thinking there is no better alternative. But if so, they had better be absolutely right and unfortunately their argument is weaker than many think.

At first the rise in inflation was near universally attributed to supply shocks. But despite the obvious role of Vladimir Putin’s attack on Ukraine and the subsequent tightening of gas supplies, prevailing opinion has somehow shifted to blaming excessive demand.

Yet it is only this year that nominal spending surpassed the pre-pandemic trend in the US; and it still has not done so in the UK or Eurozone. …monetary contraction on the cusp of a recession will make things worse for no benefit. Governments have to put in place support for those worst hit by the jump in prices. But maybe central banks – for the very sake of monetary and economic stability – should treat inflation with more benign neglect.’

In terms of the needed supply-side focus to properly deal with the inflationary crisis at hand, and in doing so limiting/avoiding recessionary spill overs in both developed and developing countries, economics Nobel laureate, Michael Spence indicated in a recently published Project Syndicate (PS) article ‘The supply side fight against inflation’ as ‘Central banks’ efforts to contain high and rising inflation are fuelling growth headwinds and threatening to tip the global economy into recession. But the proximate cause of today’s inflationary pressures is a large, broad-based, and persistent imbalance between supply and demand. Higher interest rates will dampen demand, but supply-side measures must also play a large role in inflation-taming strategies.’

A very crucial aspect of taking a rational approach to dealing with inflation and not over-reliance on squeezing aggregate demand is because with the war in Russia accentuating food supplies, with food inflation already soaring; it is therefore important to keep developing countries’ fiscal capacity in particular to provide needed subsidy to vulnerable segments of their populations on food prices, and a closely related significant determinant in the shape of oil prices, strongly feeding into food inflation.

To understand the extent of food crisis and food prices, a recent note ‘A global food catastrophe is unfolding’ by Anjali Bhatt of the Peterson Institute for International Economics (PIIE) pointed out the following: ‘The sharp reduction in food exports from important suppliers has caused the prices of these commodities to skyrocket.

The rising prices especially harm countries that import most or all of their grains from Russia and Ukraine – 25 African countries import one-third of their wheat from the region, 15 over half, and 2 – Somalia and Benin – import all of their wheat from Russia and Ukraine.

The cost of wheat in Yemen, already ravaged by war, has doubled.’ In Pakistan, food inflation as of June (year-on-year) has already sky-rocketed to 24 percent in urban areas, and even more in rural areas at 27 percent, not to mention overall inflation has increased to 21.3 percent.

Copyright Business Recorder, 2022