Heading for the worst price shock in 50 years: do governments or central banks have the resources to act?

In front of Frankfurt’s Euro Tower, home of the European Central Bank, is a giant Euro symbol.

A giant Euro sign stands in front of Frankfurt's Euro Tower, home of the European Central Bank.

JOHN MACDOUGALL / AFP

Market concerns

Faced with Covid, most developed countries have started at all costs. Is there a similar recipe (at least in terms of welfare protection effects) for a negative supply shock?

Atlantico: The World Bank has announced that we are heading for one of the biggest commodity shocks we’ve seen since the 1970s as a result of the war in Ukraine. Are we going here?

Gabriel Gimenez Roche: For now, we are indeed going there. Russia and Ukraine are major exporters of grains, as well as other raw materials such as ores, materials needed for the automotive industry or the manufacture of electronic components. They are basic products for the food industry, but also for heavy industry, increasing their scarcity on the world market.

The markets predict their scarcity within a few months. They anticipate the situation by adjusting prices through forward contracts. This is cost inflation. Producers in the tertiary sector therefore have higher costs and will find it increasingly difficult to absorb them. Ultimately, they will have to pass them on to the consumer. The latter will have no choice but to pay a higher price. You can already see this in the food and automotive sector.

Today, the question is how long this will last and inflationary pressures will arise from this.

What can we do about this situation, both at the state and central bank level?

This is all a matter of monetary and fiscal policy. When the government is faced with this kind of situation, when costs rise, the authorities decide to give households more purchasing power through fiscal fiscal policy. This can mean lower taxes or checks. In this way, the population has more monetary purchasing power and can keep up with prices. The problem is that if the situation persists, this fiscal fiscal policy will have to be continued over a long period of time and it will perpetuate the situation.

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The other solution comes from accommodating pressure by the central bank to allow the economy to absorb cost increases. It will therefore inject money to give the population more money to pay these prices. So the money will circulate throughout the economy. The money comes in through the banks and they distribute the money through loans.

There are concerns about this at the moment. Monetary policy has been used in a very active way since 2008 to remedy the problems of the financial crisis, debt, then Covid and now this war. Inflation assumes this because the money was already in circulation, but in the financial markets. Commodity prices are not rising and it seemed as if there was almost no inflation. In fact, the essence of inflation was already there. It was concentrated only in certain markets. Now the pressure is on the “real” markets and everyone can see it in the prices of consumer goods.

If we repeatedly pursue fiscal fiscal policies, we will create inflation inertia. We give checks, we lower taxes, we let the people bear the prices, but it works once because the state is in debt and we have to play with monetary policy. It is a mechanism between monetary policy and fiscal policy. One feeds the other.

Do we still have the resources to make this mechanism work?

There is a very easy way to stop inflation: to stop pumping money into the system. The problem is that it is immediately felt because interest rates rise immediately. The refinancing of companies then becomes much more expensive, as does the debt of the state and it can no longer support a generous tax policy. It is a trap and today the authorities are trapped in this trap.

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There is cost inflation. So they have two choices: either they try to grow the economy artificially, or they stop inflation right away with a recession.

In Europe, France is less exposed to inflation than Germany, but this remains linked to the issue of the war in Ukraine. However, the fuel to fuel inflation is there. There is a lot of cash, money is circulating and there is talk of rate increases. At the current level of 5 to 10% we can stop net inflation, but it could be more complicated in a situation like Argentina. Today, the most important thing is to stop the war because it affects prices and stops the pandemic in Asia.

During the Covid crisis, most developed countries launched a “whatever it takes”, could a solution like this help solve the current situation?

It is possible to do something similar and that is what President Emmanuel Macron does with the handing out of checks. All presidential candidates have proposed monetary purchasing power to try to maintain real purchasing power. But supporting inflation does not solve the problem. Interestingly, from a political point of view, this is of most interest to the population. Yet no one sees that it has inflationary power.

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