Inflation Relief? Be Careful What You Wish For!

In most of the world, inflation has been going up. That has increased
political pressure on governments to "do something" about rising
prices.

Citizens want more immediate measures than a promise of monetary policy
reducing inflation in the coming months. They are seeing their purchasing power
erode as most major economies’ wages are not keeping pace with prices.

The problem resides in potential responses from the government, which
could fall into a wide range of populist ideas.

The most recent example is the Spring Statement from UK Chancellor
Rishi Sunak. The UK has registered the highest inflation in decades. Even worse,
it could increase in the coming months. Britons were demanding some form of
relief. And the Chancellor announced a series of measures that he promised
would put more money in the pockets of consumers.

Consumer spending is the problem

Without getting into the particulars of each government's policy and
arguing over politics, generally inflation is caused by an increase in the
monetary base.

During the pandemic, factories were shut, and stores were closed. That
meant less economic activity. Nonetheless, government programs like furloughs,
and direct checks to people implied that more money was in the hands of
consumers.

In the US, for example, household savings increased dramatically as
people had more cash available thanks to government programs. They were
unwilling to spend, however, due to concerns over how the pandemic would play
out.

Over the last few months though they have started to spend, household
savings have fallen, and low interest rates have encouraged increased
indebtedness.

More dollars chasing fewer products, by the basic laws of economics,
implies higher inflation.

The cure might be the disease

Measures that put more cash in consumers' pockets as a way of fighting
inflation, in a way, is just perpetuating the problem.

Lower petroleum taxes, such as those proposed by Chancellor Sunak, are supposed
to help consumers spend less at the pump. This would also mean they have more
money available to spend on other things. In turn, this would effectively
increase disposable income and demand.

Of course, there is the matter of scale.

A 5p/liter reduction in the price of fuel isn't likely to have a major
impact. But it might help deal with popular unhappiness in the current economic
climate. A recent Ipsos poll showed that 78% of Britons expected the economy to
be worse than it is now. That is the worst score on record. In fact, it’s
matching the bottom of the 2008 great recession.

Where things can go from here

One of the major issues policy makers must deal with is that while
inflation is always a problem, this one in particular has a bigger impact on
popular opinion. Food and energy are vital aspects for the average person and
can't be delayed.

Inflation in other areas, such as electronics or vehicles from the lack
of semiconductors, is less likely to translate into popular discontent. People
don't really need to buy a new TV, or
renew their car, or even buy a house.

People can't stop going to work, and they can't stop eating. Also,
depending on where they live, they can't stop heating or cooling their home.

Governments have already blown out spending to deal with the pandemic
and are now dealing with the pinch of sanctions over Russia. They could soon be
facing more demand from citizens to resume the easy flow of cash.

For more fiscally responsible
countries, like in northern Europe, citizens are likely to be more willing to
tighten their belts. That does not necessarily apply to other parts of the
world. The issue of fiscal discipline might once again be a major wedge within
the eurozone.

It's not over by a long shot

The issue of price impacts is already one of the dividing issues within
NATO. The US is pushing for Europe to stop buying Russian natural gas and other
fossil fuels.

Germany on the other hand is reluctant to do so because importing gas
from other sources would substantially raise prices. Germans are financially
disciplined, and sanctioning Russia just costs too much.

And that's considering that Europe in general has a slightly better
inflation situation than the UK or US. The British government already caved to
its citizens and offered some concessions about reducing prices. The Biden
Administration, faced with historically low approval ratings ahead of the
midterms, would like to find every avenue to provide inflation relief for
citizens.

Stagflation or an outright
recession?

Of course, the best way to deal with inflation would be to solve the
underlying issues that cause high prices. That could either be the increased
money supply or supply chain problems.

The problem is that the former implies harsher monetary policy that
could push the economy into recession. And if the cause of inflation is the
latter, then the latest moves in monetary tightening aren't likely to fix the
underlying problem.

The thing is, for the average person, a recession and stagflation
aren't all that different. Or, arguably, a recession is better because it's
over rather quickly. Stagflation sees average people's wages eroding faster
than they grow, putting them in increasing economic pressure.

Monetary policy is afraid of the wage-price spiral. But during a year
in which many major economies are facing elections, the price-government
support spiral could be a bigger problem. That said, this could keep inflation
going longer than many economists are currently expecting.

This article was submitted by Orbex.