There is a sharp divide between those economists who view the jump in oil and food prices as part of a trend that will bring higher inflation and consequently higher interest rates and those who believe the hangover from the financial crash will dampen world demand and keep inflation in check.
Julian Jessop, the chief international economist at British research institute Capital Economics, is in the latter camp. He argued last week that pressure on inflation from the rising cost of raw materials is more modest than some have suggested.
“Upward pressure on inflation this year from the recent surge in the cost of agricultural commodities will be much greater than that from the pick-up in oil prices. Fortunately, neither is likely to be sustained,” Jessop said.
Jessop’s argument centres on economic fundamentals and the influence oil and food have on the consumer price index (CPI) measure of inflation used by governments and central banks to determine monetary policy.
The impact on CPI from rising oil prices will be limited because oil is only one element in the CPI basket of goods. A 20% rise to $90 a barrel is hurting motorists and hauliers, but is pushing average prices up by only a few decimal points. Food will have a greater impact, with a lag effect that could keep rises pushing through the CPI until the middle of the year.
Shifts in consumption
Yet policymakers should ignore concern that we are entering a new era of rapidly rising prices, he said. “While there is a lot of talk about shifts in consumption patterns as people in developing countries become richer, the upward pressure this might put on prices in future is wildly exaggerated.
“Looking ahead, we do not expect recent surges in commodity prices to be sustained. World GDP growth is still likely to be slower in 2011 as a whole than in 2010. This, with warmer weather and, if necessary, increases in supply from Organisation of the Petroleum Exporting Countries, as well as non-Opec suppliers, should pull oil prices down again. Agricultural prices should also fall back as supply recovers.”
Ray Barrell, at the National Institute for Economic and Social Research, is more circumspect. He believes higher-than-expected demand from Asian countries for raw materials could trigger a sustained rise in inflation that would need to be quelled by higher interest rates. “We’ve had a recession, but Asia has not,” he says.
Monetarist economist Patrick Minford, of Cardiff Business School in Wales, took a harder line when he told the Financial Times this week: “The Bank [of England] has drifted into dangerous nonchalance over Âstubbornly high inflation.”
Some economists argue we must forget about raising interest rates and live with higher inflation imported from the East. If inflationary prices are driven by excess demand in the East or shortages in Australian wheat, then why choke off nascent economic revival with higher rates, they ask. — Guardian News & Media 2011