Inflation is a global problem, but different countries face different pressures
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Stamping out red-hot inflation is a priority for global central banks. That was the message from policymakers — including Federal Reserve Chair Jerome Powell — attending the Kansas City Federal Reserve’s annual Jackson Hole Symposium in Wyoming last week.
As the Fed looks to continue raising interest rates in the U.S., bond markets are raising bets the European Central Bank will hike its benchmark interest rate by 0.75 percentage points next month to tackle record-high prices here.
We know inflation is a problem all around the world. But the factors driving it are different region to region.
Victoria Craig, host of the global edition of “Marketplace Morning Report” spoke with economist Dr. Mohamed El-Erian to understand why. The following is an edited transcript of their conversation, starting with what’s happening in the United States.
Mohamed El-Erian: So the biggest pressures of prices are evolving. They were initially energy and food, that was Round 1 of this inflation surge. Round 2 was a broadening to many more prices, including rent, including all sorts of goods and services. And we’ve now entering, I believe, Round 3, where wages are going to be a main driver of cost. And for the companies that still have pricing power, they will pass that on to consumers. So we will see headline inflation come down, because energy and food are less important drivers. But core inflation is going to remain, unfortunately, persistently high.
Victoria Craig: And the other part of this, too, is that before it was a demand side problem, and that’s something that central banks can sort of control. But now we’re dealing with a lot of supply-side problems, aren’t we? So is that exacerbating the inflation problem in the U.S.?
El-Erian: Yes, you’re absolutely right. I mean, we are seeing a significant structural change. And inflation is just one illustration of what happens when there’s structural change. We used to be in a world of deficient aggregate demand, there wasn’t enough demand in the system. And the Fed was concerned about inflation being too low. Now, we are living in a world of deficient aggregate supply, the problem’s on the supply side. Supply, chains, labor markets, deglobalization, the list is long. And, unfortunately, it has taken a long time for the Federal Reserve, in particular, to adjust to this paradigm change. In fact, if you look at this so-called new monetary framework, which was adopted only two years ago, it is still designed for a world of insufficient aggregate demand. And that’s why they have been so late to address this inflation surge.
Craig: Can the Fed fix this problem?
El-Erian: It can but at a high cost. And that is the problem right now. When you are as late as the Fed is — and remember, they mischaracterized inflation as transitory, once they “retired” that word from their vocabulary in November, they didn’t move fast enough, their communication has been inconsistent. Once you get yourself in a situation where you’ve made so many mistakes, you will no longer have a first, best, polished response.
Inflation beyond the U.S.
Craig: That mischaracterization of inflation, though it wasn’t just the Fed’s fault. Really, we saw central bankers all around the world think that it was a temporary problem caused by pandemic pressures. So we’ve been talking about how core inflation is really the problem in the U.S. But if we look this side of the world, it’s more food and energy prices, non-core inflation, that’s really the driver here, isn’t it?
El-Erian: It is. That’s why already the inflation rate in the United Kingdom is at 10%. And the Bank of England believes it can get to 15%. Citibank believes it can get to 18%. What you have there is a major drive on the energy side, gas in particular. And that has to do with Europe’s reliance on gas from Russia. So unlike the U.S., where the surge in oil prices is behind us now, that’s not the case in Europe. We’re still seeing gas prices going up. They’ve gone up again in the last couple of weeks. And that is adding to the inflation pressures.
Craig: How does labor factor into this? Because we talked about wages in the U.S. and how that’s putting pressure on inflation there. Here we have sort of a different dynamic, don’t we? Because we’ve got absences from COVID. We’ve also got labor shortages because of Brexit. How much do you think is down to the effects of the U.K. leaving the European Union?
El-Erian: Part of it is but there’s a broader issue: COVID has changed the functioning of the labor market. Labor force participation has come down. And you get the sort of disruptions that we’ve all experienced. Whether it’s when you go to an airport, when you try and fly, whether when you go to restaurants. The service sector in particular has been hard hit. What you seeing in the UK, that you haven’t yet seen elsewhere, is labor is pushing back very hard at inflation. So we are seeing strikes as labor tries to protect its purchasing power. When you have 10% inflation, your ability to buy things gets eroded very quickly. And you resist that. It is now a U.K. phenomenon in particular, but I suspect that we will see it increasingly in the U.S. Continental Europe is less clear.
Craig: Is there a risk that strikes could even further worsen the economic situation, because rail strikes that we had here — if it prevents people from being able to get to work to do their jobs, could that result in a further slowdown and more inflation pressures down the line?
El-Erian: Yes, it adds to the supply disruptions. We have three elements adding to the supply disruptions right now around the world: strikes, for example, the weather (low levels of rivers and everything else), that’s also disrupting supply. And of course, there’s the zero-COVID policy in China. We are having that, on top of the more structural aspects that we talked about earlier.
Craig: And the Bank of England hasn’t been behind the curve, so to speak, on trying to battle these inflation pressures and the economic problems. They have been raising interest rates, and they have been trying to tackle it. But they are getting a lot of flack for not being able to solve it. As you mentioned, the city forecast this week, calling for 17%, 18% inflation down the line. I mean, is there more that the Bank of England can do? Is the criticism that it’s receiving justified?
El-Erian: So I think that if you look at the Bank of England, it actually has outperformed other central banks. It’s been the central bank that has tried to be very honest about the outlook, saying some pretty unpopular things, but trying to act as central banks do, which is technocrats that are trusted advisors to the rest of society. Governor Andrew Bailey has been criticized for that. But in my opinion, that’s what a central bank should do. Yes, it got trapped into transitory characterization, but it got out of it much earlier than others. And they started raising interest rates. The problem that the bank has is that it’s dealing with a very complicated situation. You mentioned Brexit, gas. So if you were to judge in terms of degree of difficulty, what it faces is much more difficult when the what the Fed faces. But it’s not as difficult, I want to stress, as the European Central Bank. That is where the policy challenges are the most acute.
Craig: And why do you think that is? Is that just simply because it’s managing 19 different economic realities?
El-Erian: Absolutely. It is managing 19 different economic realities. It is worried about fragmentation, which is the fancy word of saying the markets will start differentiating between 19 members, which makes monetary policy very difficult to be effective. And also, the European economy is very weak. I suspect we will see that it will be in a recession. It’s going to be in a recession if it’s not already in a recession, and it faces a very difficult winter.
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