In advanced economies, consumer price inflation, a mere 1% per annum during 2015-20, rose to 3% in 2021 and is projected to reach about 6% in 2022. Compared with 1% per annum or less in the preceding five years, the corresponding inflation rates in 2021 and 2022 are 4.7% and 7.7% in the US, 3.2% and 5.5% in Germany, 2.6% and 7.4% in the UK, and 2.6% and 5.3% for the Eurozone, with Japan as the sole exception. These projected inflation levels in rich countries, for 2022, are unprecedented and have not been witnessed since the oil crises of the 1970s fifty years ago. In developing economies, where consumer price inflation was on average 5% per annum during 2015-2020, corresponding inflation rates are 6% in 2021 and 9% in 2022. Asia is the sole exception where inflation is moderate. For Latin America, Sub-Saharan Africa, and Middle East & Central Asia, inflation reached double-digit levels in 2021 and will climb further in 2022. In Developing Europe (non-EU transition economies), the corresponding rates are 10% and 27% per annum.
The factors underlying inflation are obvious. First, during 2020-2021, most central banks adopted easy monetary policies while governments adopted expansionary fiscal policies in response to the covid pandemic and its associated lockdowns that led to a devastating contraction in output and employment. The unintended consequences were that significant proportions of cheap money went into financial assets—driving stock market booms in an economic slump—and primary commodities, pushing up world prices. Second, in early 2022, the war in Ukraine accentuated inflation as it squeezed world supplies of fuels (oil and gas from Russia) and food (wheat from Ukraine), while the sanctions and the war disrupted supply chains. Mounting inflationary expectations are an obvious consequence.
This has coincided with a sharp slowdown in growth worldwide. In advanced economies, gross domestic product (GDP) growth, which was 2% per annum during 2015-2019, slumped to -4.5% in 2020 while 5.2% in 2021 meant a return to GDP levels in 2019. It is the same story for most rich countries. In developing economies, GDP growth, which was 4% per annum in 2015-2019, dropped to -2% in 2020, recovered significantly to 6.8% in 2021 (attributable mostly to China and India) more than returning to GDP levels in 2019, but will drop to 3.8% in 2022 (propped up by Developing Asia). Latin America and Sub-Saharan Africa fared worse, Developing Europe is the disaster story (Ukraine war), while the Middle East might do better because of high oil prices.
After the financial crisis of 2008 and the Great Recession that followed, global growth had not returned to its boom levels seen until 2008, as the recovery was slow and uneven. The pandemic saw a sharp output contraction everywhere. Disruptions and uncertainties of the war will dampen growth further. Thus, world GDP in 2022 could well be at its 2019 level.
The consequences of such high inflation juxtaposed with dampened growth are bound to be asymmetrical between the rich and the poor, countries or people. The prolonged pandemic has already hurt poorer people and countries far more, while the economic recovery is K-shaped. Economic inequalities worldwide, already high, will widen, with inevitable social and political consequences.
The response of governments to inflation almost everywhere reveals a return to orthodoxy in macroeconomic policies. Central banks are hiking interest rates while governments are starting fiscal consolidation to restrain and manage inflation. This solution might accentuate rather than resolve the problem. The reason is simple. The present inflation is driven by supply-demand imbalances, particularly in fuels and food, and war-induced disruptions in supply chains, where uncertainties are shaping inflationary expectations. Raising interest rates will not curb such supply-side inflation. If the diagnosis is wrong, the derived prescription cannot resolve the problem. In fact, this misconceived remedy might end up stifling growth further. Higher interest rates will dampen investment while fiscal consolidation will squeeze consumption expenditure, which are the main sources of aggregate domestic demand. Such contractionary macroeconomic policies could end up stifling growth.
What needs to be done is almost the opposite. Monetary policy is a powerful instrument for stimulating investment, while fiscal policy is a powerful one for stimulating consumption expenditure (specially to meet consumption needs of the poor), to revive growth. Thus, unless government policies strike a balance between managing inflation and stimulating growth, stagflation will be the most likely outcome.
We must not forget that price stability and balanced budgets are neither ends nor virtues in themselves. The well-being of people should be the primary concern of governments. Moreover, price stability and economic growth must not be posed as an either-or choice. That is a false dilemma. In fact, the well-being of people and economic progress of countries requires stability with growth.
Deepak Nayyar is emeritus professor of economics, Jawaharlal Nehru University, New Delhi
