Understanding inflation in advanced economies
Almost all advanced economies in the world are debating with the growth versus inflation question at the moment. While inflation numbers have been breaking records, central banks and monetary hawks are increasing the pitch for more radical monetary policy action to contain prices even if it generates headwinds for growth momentum.
Almost all advanced economies in the world are debating with the growth versus inflation question at the moment. While inflation numbers have been breaking records, central banks and monetary hawks are increasing the pitch for more radical monetary policy action to contain prices even if it generates headwinds for growth momentum.
To be sure, global growth momentum is already on a downward trajectory and the deceleration has come faster than expected. For example, World Bank’s Global Economic Prospects for June 2022 expects global growth for 2022 to be 2.9% -- a sharp downward revision from the 4.1% forecast made in January 2022. Of course, the biggest change between the January and June forecasts has been the Russian invasion of Ukraine which has sent commodity prices soaring.
How serious is the inflation problem in advanced economies? Is it just a by-product of the Russia-Ukraine war, or is there more to it? Where will politics gravitate in the growth versus inflation debate? This two-part data journalism series will try to answer some of these questions. The first part will give some stylised facts on inflation and the second part will look at the political economy aspects of it.
The Russia-Ukraine war has added to inflation, but prices were rising before the war
An ability to manage inflation well is considered to be among the biggest successes of macroeconomic policy in advanced economies. Inflation fell from already very low (and normal) levels when the pandemic started in early 2020, primarily a result of crash in demand for various goods and services. However, prices started recovering as economies opened up and vaccines became available. While some of the runaway inflation was just base effect – an artificial boost because of lower price levels in the previous period – inflation gained momentum by the beginning of 2022. This is true for both G7 countries – it includes US, UK, Japan, Italy, Germany, France and Canada – and the Euro Area. To put things in context, the combined GDP of G7 and Euro Area countries had a share of 43.4% and 13.9% in world GDP for 2022.
See Chart 1: Historical inflation numbers for G7 and Euro Area
How high are these numbers historically speaking?
A comparison of the latest numbers for G7 with the past shows the inflationary concerns to be broad-based. While the US has the highest inflation of 8.6% for May within G7, it is also the highest by historical standards. US inflation has been lower than this number since January 1982, shows the Bureau of Labour Statistics (BLS) data. While Japan has the lowest inflation of 2.5% for May within G7, it is still the highest since November 2014, shows OECD data. UK’s May inflation of 7.9% is the highest rate since May 1991, as per data from Organisation for Economic Co-operation and Development (OECD). The Canadian May inflation of 7.7% is the highest since February 1983. The French May inflation of 5.2% is the highest since October 1985. The German May inflation of 7.9% was last seen on December 1973. The Italian May inflation of 6.8% was last seen on November 1990.
See Chart 2: Annual growth in inflation of individual G7 countries for May and their historic highs
US inflation is more broad-based than Euro Area at the moment
If one looks at the components of the CPI basket, the drivers of inflation seem to be different in the US and Europe. In the US, prices of energy, food, and other non-food and non-energy commodities grew at the fastest pace with subcategory-wise annual inflation at 34.6%, 10.1%, and 8.5% respectively in May, shows BLS data. In the Euro Area, prices of energy, housing, water, electricity and gas, and transportation grew at the fastest pace at 39.1%, 16.3%, and 14% over the same period, shows OECD data.
Moreover, these inflationary pressures are more broad-based in the US than in the Euro Area. In fact, items of the CPI basket such as education and communication have shown negative annual growth of 0.9% and 0.4% respectively for May in the Euro Area, while all CPI items in the US have shown a positive growth. Even after excluding the volatile component such as food and energy prices from CPI, the core CPI in the US grew by 6% in May, while it was 3.8% in the Euro Area.
Harvard Economist Jason Furman reasons that some of this rise in core inflation in Europe was imported from the US. “Since the pandemic started, the US has spent cumulatively an extra $600 billion on goods, which is roughly 4% of the world’s total annual goods consumption (assuming a third of global consumption is spent on goods). In contrast, Europe has spent below-trend amounts on goods over that period. High US demand in conjunction with global supply-chain problems is driving up spending on goods all over the world”, he wrote in a Wall Street Journal article on June 6 (https://on.wsj.com/3OE5UUw ).
See Chart 3: Core inflation in US, G7 and Euro Area
This is the first of a two-part data journalism series on inflation in advanced economies. The second part will look at the political economy around inflation.
