Inflation and economic crisis: when we will get out
In a nutshell, we can describe the current high inflation environment as one imbalance between supply and demand unexpected and difficult to manage. Consumer price inflation, which has reached double digits in some countries, indicates that many economies are no longer in equilibrium. Under the ground rules, the recipe for fighting inflation is to reduce demand and increase supply. Of course, this represents the ideal scenario.
But, in practice, how could the path of returning to a situation of equilibrium be outlined? When it comes to curbing demand central banks play a key role, in particular with reference to interest rate decisions. Indeed, the tightening of rates leads to an increase in the price of all types of credit: the demand for capital goods, consumer goods and housing, all other things being equal, decreases. However, the effects of rate hikes are not immediate.
The extent of the delay is generally equal to at least one year, but can only be estimated. Meanwhile, central banks try to demonstrate their determination not just in words; think of the very uncompromising statements recently released by Federal Reserve (Fed) chairman Jerome Powell and the rate hikes made by the US central bank.
Powell he remarked that the Fed will have to intervene for an extended period of time and warned against the risks of an early rate cut by referring to lessons learned in the past. According to the Fed’s projections, the reference rate should stand above 4.5% in the spring of 2023. The other central banks, for their part, are certainly not idle. In September, just to name a few, the European Central Bank, the Bank of England and the Swedish Riksbank also raised their respective key rates sharply.
Said this, the problems on the supply side remain. What adjustments could mitigate price pressures? In the short term, the increase in the supply of components such as microchips or raw materials such as construction timber is supported by the gradual easing of the situation at the level of supply chains and transport capacities.
For certain products the price spikes should therefore be near by now. Energy prices in Europe have partially stabilized as gas reserves have been replenished earlier than expected, but still remain very high compared to the historical average.
Supply problems on the labor market can only be effectively addressed in the long term, for example through immigration, but in the short term the situation remains critical. Just think that, according to a recent study, today due to the consequences of the pandemic in the United States, the workforce is below the 2019 level of around 500,000. Therefore, in order to see a normalization of wage dynamics, a decline in the demand for labor will be required.
In general, we can say that, in all probability, in the medium term, the restoration of a situation of equilibrium will depend above all on the reduction in demand.
Investors, on this path of returning to equilibrium, will still find themselves facing a difficult environment. You need to be patient as the process will take time. If nothing else, an encouraging signal comes from expectations about the economy and the trend in reference rates, which now appear more realistic than in recent months.
* Senior Investment Strategist, Global Economics & Strategy of Allianz Global Investors
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