July 18, 2022
Inflation has been accelerating since the reopening of economies around the world from COVID lockdowns. It’s causing an inflationary shock that is stretching longer than expected, fueled by persistent supply chain disruptions and the war in Ukraine.
The good news is that the inflation picture should become better. Supply chains are showing encouraging signs of improvement as businesses diversify their suppliers. And while the war and accompanying sanctions on Russia are still hampering several commodity markets – notably food and energy – the worst of the initial shock appears to be behind us.
On the flip side, price increases will remain substantially higher than those observed a year earlier for several more months.
Shortages have led companies to massively boost inventories with many businesses moving from “just-in-time” inventory management to “just-in-case.” As they try to meet the high demand and build inventories, they are contributing to further clogging of transportation networks.
High oil prices are also contributing to inflation as global crude supply struggles to meet demand. Obviously, surging oil prices are being felt by motorists at the pump, but they are also having significant spillover effects elsewhere in the economy. For example, energy is a major input in commodity production and distribution.
Central banks have no choice but to hike rates and act aggressively being faced with high levels of inflation and tight labour markets. In 2008-2009, central banks around the world adopted extremely low-interest rates in response to the financial crisis. The US Federal Reserve lowered its key interest rate to 0 percent in December 2008 to stimulate the economy. It kept it at that level until December 2015 when it began to modestly raise the rate until it reversed the trend once again in response to the pandemic.
While the interest rate environment in the coming years will look different than what we’ve seen in recent years, this is not bad news. The risks of sustained inflation remain high. Despite the discomfort of rapid rate increases, they’re necessary for the economy to return to a healthy and sustainable pace of growth.
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