Commentary RESEARCH

Restorative prescription

Aria

2022-09-16 12:00

Alvin Chua and Li Chen
China Daily

Uneven global inflation is symptom of underlying economic challenges

With escalating inflation, volatile financial markets selloffs and ongoing disruptions caused by the Russia-Ukraine conflict, the global economy is confronting the risk of stagflation, a bleak situation that combines elevated inflation, weak growth and persistent unemployment, which is not unlike the circumstances of the 1970s.

This global inflation surge has been highly uneven. Food and energy costs are its main drivers, substantially eroding the global standard of living and causing severe economic pains worldwide. The International Monetary Fund's latest analysis in July projected inflation to reach 6.6 percent this year in advanced economies and 9.5 percent in emerging markets and developing economies. With interest rate hikes and monetary policy tightening in the United States and the European Union, the global economic growth may slow to only 2.9 percent next year.

In the US, the Federal Reserve has been widely criticized for being behind the curve in the battle against inflation, but its monetary policy has been catching up with a series of interest rate hikes and quantitative tightening. According to the US Bureau of Economic Analysis, the US Personal Consumption Expenditure Price Index, the Fed's preferred inflation gauge, dropped by 0.1 percent month-on-month in July, the first decline in 20 months since April 2020. However, from the same month one year ago, the PCE price index for July still increased 6.3 percent.

As a major exporter of natural gas and agriculture products, the US has energy independence and is self-sufficient in basic food production. With low levels of unemployment, the Federal Reserve still has the political space for more monetary policy tightening. The inflation surge in the US may decelerate in the coming year as the Fed continues to raise interest rates and tighten monetary policy.

The situation is far worse in Europe. Much of Europe is dependent on gas imports from Russia. As Russia has suspended the natural gas flow through the Nord Stream 1 pipeline, Europe is facing a huge energy supply challenge, even more so in the coming winter. Eurozone inflation reached 9.1 percent in August (year-on-year) vs 8.9 percent in July. German inflation reached 8.8 percent, a 40-year high, with energy prices increasing 35.6 percent and food prices increasing 16.6 percent. Inflation will likely continue to rise in Europe in the near term, and the risks of recession and even deindustrialization are high.

Since the eurozone debt crisis bailout, the eurozone has enjoyed a decade of ultra-low interest rates. Policymakers began pushing interest rates to the negative territory in 2014. To fight the soaring inflation, the European Central Bank raised its policy rate in July, for the first time in more than 11 years, and lifted its deposit rate out of negative territory for the first time in eight years. The transition from negative to positive interest rates will likely be a very difficult and painful journey for the eurozone economy.

Unlike in the US and Europe, the inflation in China remains benign. According to China's National Bureau of Statistics, the consumer price index last month rose only 2.5 percent year-on-year, and actually decreased 0.1 percent month-on-month. The benign inflation outlook has provided China's policymakers with more flexibility to ease interest rates and implement fiscal stimulus. With the recovery of supply chains and logistics, China's export growth has rebounded significantly, rising 13.5 percent year-on-year in dollar terms for the first eight months of 2022.

China's State Council, the Cabinet, has recently announced a series of pro-growth policy measures. Among other things, the government will increase credit quotas by 800 billion yuan ($115 billion) and financial instruments quotas by 600 billion yuan for policy banks to support infrastructure development and innovation. The policymakers will also guide the lowering of funding costs to boost economic recovery.

To navigate the challenge of the uneven inflation surge worldwide and mitigate the risks of stagflation, we need to foster global cooperation and improve international policy coordination. First, leading international organizations such as the World Bank, as well as high-income countries, need to strengthen their aid and support to developing countries reliant on food and energy imports. The surging inflation has wreaked havoc on a number of developing economies. From Argentina and Chile to Sri Lanka and Peru, the rising food and fuel prices have caused severe social and economic instability. The global development policy community should help reduce the burdens faced by those most vulnerable to the inflation crisis.

Second, we need to focus more on supply-side policy measures rather than demand-side management. The monetary policy tightening and interest rate hikes can surely help to curtail excessive demand, but can do little to correct the supply chain disruptions. We need genuine international collaboration to reduce geopolitical tensions and restore the efficiency of the global supply chains. For instance, to help ease inflation, the US should eliminate or reduce the harmful trade war tariffs on the imports from China and other countries introduced during the Donald Trump Administration. We also need to accelerate new investment and promote innovation in the energy and food sectors.

Third, we need to stay vigilant to potential financial instability as the global monetary policy environment normalizes and also diverges. The paradigm shift from loose monetary policy and ultra-low interest rates to tighter liquidity and higher interest rates is inevitably fraught with risks of financial turbulence and recession. We have already witnessed synchronized stock market and bond market selloffs as well as volatile exchange rate shifts this year.

Faced with uneven inflation and growth conditions, it's not surprising that major economies are pursuing divergent monetary policies, with the US and Europe more proactive in tightening, Japan staying the course of loose monetary policy, and China adopting a new easing and stimulus policy. In such a complex environment, we need to improve global policy coordination to safeguard international financial stability.

We are living in a world characterized by profound volatility, uncertainty, complexity, and ambiguity. The uneven global inflation surge has brought massive challenges to both high-income economies and developing economies. However, it's important to realize that the global inflation is more of a symptom rather than the root cause of the economic disease. What's underlying the current global inflation surge are the fundamental challenges of geopolitical tensions, deglobalization tendency, inequality, climate change acceleration, and supply chain volatilities. We need effective global cooperation to deal with these pressing long-term problems.

Alvin Chua is a managing director at Bank of China International. Li Chen is an associate professor at the Chinese University of Hong Kong. The authors contributed this article to China Watch, a think tank powered by China Daily.

 


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