The after effects of the pandemic and the war in Ukraine have combined to place upward pressure on a wide range of goods, most notably in fuel, energy and agricultural products – areas where there is little discretion available as to whether or not we choose to maintain consumption.
Already we are seeing calls for greater support for beleaguered families faced with higher living costs outstripping any rise in their income. Pressure is mounting for the government to introduce measures to help mitigate these rising costs, but it is difficult to see anything other than token assistance being made available. Wage inflation could be just around the corner, though this would only exacerbate the situation. But it won’t stop unions threatening strike action if wages are not raised. -
Recessions and stagflation do not happen that frequently.
Clearly the preferred solution is for governments and central banks to introduce measures to rein in the rise in the cost of living. The big concern that many economists have is whether such action taken to calm inflationary pressures will tip the global economy into recession. Traditionally the main weapon to be employed against a rising cost of living is higher interest rates. Already we are seeing rate rises here and in the United States, while the European Central Bank has indicated that they will also be raising the cost of money.
This can only add to the pressures being felt by many consumers, with mortgage costs likely to rise. Interest rates have been so low for a lengthy period that many homeowners have much larger borrowings in relation to their incomes and the value of their property than once used to be the case. The natural consequence of such a squeeze on incomes would be for spending to be diverted away from discretionary areas, which is likely to impinge on economic growth.
In the past such a contraction of spending and economic activity has placed a cap on inflation, but these are not usual times. While the disruption of supply chains that resulted from the pandemic can be expected to be ironed out, continuing hostilities in Ukraine look likely to prolong the period during which food and fuel costs can be expected to rise. The initial hit to our cost of living may have been higher gas and oil prices, but it is now foodstuffs and related agricultural products that are taking up the running.
This widens considerably the effects of this crisis, with food shortages now expected around the world and an almost inevitable reduction in spending as a result. Yet central banks feel they must act, even if the rate rises will still leave the cost of money way below the prevailing inflation rate. The worst case scenario is a stagnant or contracting economy and high inflation, known as stagflation. The effect of this is to intensify the squeeze on disposable income, thus reducing the spending power of the average consumer – something that is already taking place.
Breaking out of such a cycle will not be easy, but it will be high on the agenda for those governments faced with this problem. What is more difficult to judge is the extent to which what is taking place now is a natural consequence of recent events with a finite life, or a major shift in expectations of how inflation should be viewed for the future. If the former, central banks will doubtless be more moderate in their actions and may even manage to avoid recessionary conditions. It is the latter scenario that will be giving those tasked with managing the economy sleepless nights.
Here in the UK we have the problems created by Brexit to factor in to our calculations. This has resulted in a tight labour market, particularly in certain areas, like agriculture. This may embolden workers to demand higher wages to compensate for their rising living costs, which would simply add to the spiral. And the only way out of such a dilemma is to tighten monetary policy to the extent that recessionary conditions become unavoidable.
Recessions and stagflation – the S word – do not happen that frequently. Economic management has improved massively in recent years, so we must hope a way may be found to avoid the worst case scenario. An early resolution to the conflict in Ukraine would undoubtedly help, though this is looking far from likely. Resolving supplies of energy and fuel is probably easier to achieve than replacing the lost foodstuffs from Russia and Ukraine. Messrs Johnson and Sunak may have rather more to worry about than parties at No 10 in the months ahead.
Illustration by Jordan Atkinson