Inflation: Why is Everything so Expensive Right Now?
Global energy prices have collapsed, the price of food on international commodity markets also appears to be reducing, so for how much longer can we justify the rise in prices to the Ukrainian war? Is ‘greedflation’ to blame?
Earlier this week, the Bank of England (BoE) increased interest rates to 4.5% as inflation is expected to stay higher for a prolonged period of time than previously anticipated.
The goal? To dampen double-digit UK inflation currently standing at 10.1%.
Simply put, when inflation is high, central banks raise interest rates to regulate the rise in prices. Higher interest rates increases the cost of borrowing, which reduces consumer and business spending, encourages saving and therefore leads to lower demand for goods and services — which in theory would contribute to reducing inflation.
This would imply that demand for goods and services is extremely high at the moment, but this is not all which is driving higher prices — it seems that a large proportion is being driven by supply-side inflation. In which case, was raising interest rates the right solution?
Suggested Causes of Inflation at a Glance:
1. Global Factors
Notably, global factors are fuelling the increase in commodities — high energy prices for example are feeding through into higher costs of goods and services. Post Covid, oil and gas were in greater demand as people began to live normally again — but the war in Ukraine applied further pressure onto the price of these fuels.
2. Greedflation
Some economists have crucially suggested that high inflation is persisting due to systematic profiteering by some companies across the economy, and so inflation in food and energy would be likely to reduce at a slower rate than anticipated as businesses hesitate to bring down prices.
Trade union leaders described this “greedflation” by companies who are using the cost of living crisis to justify an uplift prices more than necessary.
The GDP Deflator graph above allows you to see how much of the pricing pressure can be attributed to profits, and how much to the increase in wages. Draw your attention to the red bars, that’s showing you how much of the rise in prices in the past few years can be attributed to profits.
According to Sky, whilst some argue that this is simply the way business works when there is high demand and it is not necessarily profiteering, others are convinced that a huge proportion of this comes down to the “greed of business”.
The above GDP Deflator graph was specifically for the Eurozone, how about the UK alone?
Within the same piece of research by Sky News, the UK seems to have considerably less of ‘greedflation’ relative to other countries in the Eurozone. It appears to be taxes which have contributed much more to inflation in 2021 and into 2022 than business profits.
3. Money Printing
During lockdown, the availability of goods and services were heavily impeded as global supply chains became disrupted. To tackle this, a policy response by central banks necessitated an increase in the money supply at a time of falling supply- further contributing to inflation. The Former Governor of the BoE recently stated the following:
“All central banks made the same mistake during Covid… the economy was actually contracting because of lockdown and central banks printed a lot of money, that was a mistake that led to inflation.”
You can see more on this discourse here.
Conclusion
Typically, a rise in inflation calls for a rise in interest rates by central banks as higher interest rates compels consumers to save more and spend less — reducing demand for goods and services and thus bringing down prices.
However given the strain on the current energy supply, inflation appears to be supply-driven. High energy prices are resulting in an increase in the cost of production, leading to higher prices of goods and services.
The former Head of Labour Market Analysis at the Office for National Statistics Jamie Jenkins suggests that increasing interest rates does not address the root cause of inflation, and increasing the interest rate is only exacerbating the fall in living standards for consumers who are facing constraints on their disposable incomes.
The list above is by no means exhaustive, but highlights the main topical areas which explain the current rise in prices — Some of which have been advocated by critics to argue against the rise in interest rates as a means of tackling inflation.
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