Inflation has come back faster, spiked more markedly, and proved to be more stubborn and persistent than major central banks initially thought possible.
After initially dominating headlines in the US, the problem has become a centrepiece of policy discussions in many other advanced economies.
In 15 of the 34 countries classified as AEs by the IMF’s World Economic Outlook, 12-month inflation through December 2021 was running above 5 per cent. Such a sudden, shared jump in high inflation (by modern standards) has not been seen in more than 20 years.
Nor is this inflationary surge limited to wealthy countries.
Emerging markets and developing economies have been hit by a similar wave, with 78 out of 109 EMDEs also confronting annual inflation rates above 5 per cent. That share of EMDEs (71 per cent) is about twice as large as it was at the end of 2020. Inflation thus has become a global problem — or nearly so, with Asia so far immune.
The primary drivers of the inflation spike are not uniform across countries, particularly when comparing AEs and EMDEs.
Diagnoses of “overheating’’, prevalent in the US discourse, do not apply to many EMDEs, where fiscal and monetary stimulus in response to Covid-19 was limited, and where economic recovery in 2021 lagged well behind the AE rebound.
Moreover, the pandemic-induced bust-and-recovery patterns differ markedly across country income groups, with recovery being defined as an economy’s return to its 2019 level of per capita income.
About 41 per cent of high-income AEs met that threshold at the end of 2021, compared to 28 per cent of middle-income EMDEs and just 23 per cent of low-income countries.
But the disparity between advanced and developing economies is even greater than this comparison suggests, because many EMDEs were already experiencing declines in per capita income before the pandemic, whereas AEs were mostly at new highs.
While many EMDEs have marked down their estimates of potential output over the past two years, there is little to suggest that their inflationary pressures are driven primarily by overheating in the aftermath of significant policy stimulus.
One development that is common across advanced and developing economies is the increase in commodity prices alongside rising global demand. As of January 2022, oil prices were up 77 per cent from their December 2020 level.
Another major issue affecting advanced and developing economies alike is global supply chains, which continue to be severely affected by the events of the past two years.
Transport costs have skyrocketed. And unlike the oil-based supply shock of the 1970s, the Covid-19 supply shocks are more diverse and opaque, and therefore more uncertain, as the World Bank’s most recent Global Economic Prospects stresses.
In EMDEs, currency depreciation (owing to lower inflows of foreign capital and downgrades of sovereign credit ratings) has contributed to inflation among imported goods. And because inflation expectations in EMDEs are less anchored and more attune to currency movements than in AEs, the pass through from exchange rates to prices tends to be faster and more pronounced.
Another important factor is food price inflation. During 2021, 12-month increases in food prices exceeded 5 per cent in 79 per cent (86 out of 109) of EMDEs. While AEs have not been immune to rising food prices, just 27 per cent of them experienced price hikes exceeding 5 per cent.
Worse, food price inflation also generally hits lower-income countries (and lower-income households everywhere) particularly hard, which makes it tantamount to a regressive tax. Food accounts for a much larger share of the average household consumption basket in EMDEs, which means that inflation in those economies is likely to prove persistent.
Today’s higher energy prices will translate directly into higher food prices tomorrow.
© Project Syndicate, 2022
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