Inflation and purchasing power: keep calm

On the one hand, the rise in prices is largely related to the global demand for goods and products, which has increased strongly after the periods of confinement caused by the pandemic; this development was fueled by government bailouts and liquidity injected by central banks.

Increased demand also encountered a slowdown in production. Many factories were unable to restart operations quickly enough. Measures taken to contain the pandemic have disrupted supply chains. And now the war in Ukraine is causing new supply problems, as well as a rise in the prices of raw materials and energy, making production more expensive.

Difference Between Rising Prices and Inflation

Despite everything, prices in Switzerland rose much less than abroad. This can be explained in particular by the strength of the franc, which dampens the introduced inflation. The composition of the price index also plays a role: Switzerland spends less on fossil fuels than Germany or the United States. And companies use energy more efficiently.

That said, rising prices are also being felt in Switzerland, especially within companies. Compared to March 2021, producer prices rose by 6.1%, those of imports by 10.2%.

Price developments threaten purchasing power

Due to the increase in rates, many companies are forced to adjust their prices. This movement will continue in the coming months. Although much of the price pressure will be absorbed through margins, logistical disruptions, rising energy prices due to the war and shortages of components will be felt.

However, a price increase does not mean inflation. There is only inflation if prices rise on a large scale and remain at a high level. An important part of the current increases is caused by the shortage of energy, raw materials or semi-finished products. These high prices show the existence of shortages and the need to use goods sparingly. This cannot be compared to a situation where in general all prices rise as a result of an overly expansive monetary policy and where inflation weighs on purchasing power. In other words, we are dealing in Switzerland with imported inflation and not with inflationary developments. So we cannot speak of a general decline in purchasing power in Switzerland at the moment.

Monetary policy should be normalized

Admittedly, the situation is worrying in many countries. If the price increase continues and the economy stagnates, we speak of stagflation. Moreover, if production were to fall, we would face a recession accompanied by high inflation. There are three important levers to put a stop to such scenarios – and thus loss of purchasing power.

First, monetary policy must normalize quickly. Price stability is the most important task of central banks. The US (Fed) and UK institutions have already raised their key rates. The European Central Bank is still hesitant, but should follow suit. The measure is expected in view of the level of inflation. Even if the pressure in Switzerland is less, the SNB should also raise its interest rates.

Stay calm

Secondly, politics also plays a role. Given the record level of government debt – especially in the eurozone – the rise in interest rates is running against the risk of sovereign solvency. In Switzerland, too, the independence of the SNB is being questioned: its expectations range from financing climate programs to consolidating the AVS. Politicians would do well to refrain from such demands. To avoid fueling inflation, it is recommended to curb government spending.

Third, keep calm. Unions’ demands for generous price compensation are counterproductive. If companies want to raise wages on a large scale, sooner or later they will have to raise their prices and then the dreaded price-wage spiral begins. A situation of imported inflation would be followed by general inflation. Due to the shortage of skilled labor, companies would react individually to make up for a possible loss of purchasing power. But now is not the time to sound the alarm.

So there is room for maneuver to avoid negative scenarios. But it is clear that reacting too late to inflation would be very costly economically and bad for purchasing power.

This text appeared on May 2, 2022 in “Le Temps”.

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