Reserve Bank governor Lesetja Kganyago has underlined on a number of occasions that high inflation is harmful to consumers, particularly the poor. Photo: Gem Atkinson/Bloomberg via Getty Images
Inflation. No issue has seemed to occupy the minds of monetary policymakers more in recent history.
There is a good reason for this. For a long time many central banks were convinced that high inflation was a blip, the result of recovery-related supply chain chokeholds that would eventually subside. But inflation has been more intractable than many analysts previously imagined it would be, climbing to decades-long highs in some economies.
Policymakers, including our own, have started to change the way they talk about inflation. Recently, the South African Reserve Bank’s monetary policy review noted that inflation has become “increasingly less transitory” — a fact that has prompted many central banks to change tack and become more aggressive in their efforts to quell the spike in prices.
As Reserve Bank governor Lesetja Kganyago has underlined on a number of occasions, high inflation is harmful to consumers, particularly the poor, who end up having less disposable income because they are spending more on basic goods and services. Although domestic inflation may currently be higher than the bank is comfortable with, it has not breached the 6% limit.
Confirmation that inflation could be here to stay came last week, when the International Monetary Fund (IMF) warned that the pressures pushing prices up are likely to persist into 2023. Troublingly, these pressures have become increasingly broad-based, a sign they may become more entrenched in the global economy.
So why has inflation come as such a shock to policymakers?
For many years now, global inflation has seemed to be a phenomenon of the past. The last time inflation got out of control was in the 1970s during the global oil crisis. In the early 1970s, the oil price quadrupled. The spike in oil prices, as well as a wage-price spiral in the US and Europe, resulted in runaway inflation that took years to temper.
During that period, unemployment also started to climb and economic growth stagnated, leading to what then became known as stagflation. A resurgence of stagflation hasn’t been a major worry until now, as elevated prices have been symptomatic of an all-too-healthy economic rebound, especially in the US.
But the tide has started to turn. Last week, the IMF revised down its global GDP projections, while also revising up its inflation forecasts.
This perfect storm of economic headwinds has emerged mainly because of the effects of Russia’s assault on Ukraine, which has compromised global energy and food supplies. Another strict Covid lockdown in China has also aggravated supply-side pressures.
The paired threats of high inflation and low economic growth put policymakers in an awkward position. To keep inflation in check — and, therefore, protect the values of their currencies — central banks may roll back policies that are good for economic growth, such as low interest rates. The most tangible way that they do this is by raising the cost of borrowing.
When the US Federal Reserve (Fed) intervened in the 1970s crisis by raising interest rates, it ultimately drove the country into a recession in the early 1980s.
Keeping inflation from spiralling is regarded as important because many economists believe that high prices can scar the economy. In 2015, researchers at Cambridge University conducted an inflation stress test, which modelled what would happen if inflation again soared to untenable levels. In its most benign scenario, in which the inflation rate peaks at about 6% globally, the global GDP would contract by $4.9-trillion.
By the IMF’s recent projections, inflation in advanced economies will average 5.7% in 2022 and 8.7% in emerging market economies.
Emerging markets have already responded to high inflation by starting to raise rates. The South African Reserve Bank began gradually lifting the repo rate last November, which now stands at 4.25% a year.
Though the Fed has remained relatively amenable in the face of higher-than-expected inflation, it is now poised to raise interest rates at the fastest pace in decades. Last week, Fed chairperson Jerome Powell said the bank will start raising rates to a neutral level. It will have to try to do so without pushing the country into a recession.
Meanwhile, tighter monetary policy stateside will result in a stronger dollar, which will knock the price of commodities. South Africa’s economic growth has been buoyed by the healthy demand for the country’s commodities, which could also be in peril if the global economic rebound slows significantly.
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