This week, as I made my weekly pilgrimage to the newspaper kiosk in Paris, I was faced with a grim realisation. When I handed the vendor €7.50 in exact change for The Economist magazine, he replied saying “8.50 euros monsieur!” He then passed the issue with the headline, ‘The Fed That Failed: How inflation humbled America’s central bank.’

Inflation has permeated our lives once again. Consumer prices in the US last soared as high as now back in the 1980s, a period characterised by high prices followed by a fall in demand and the oil glut. Inflation has gone over 8 per cent in the US with the Euro area is not far behind at 7.5 per cent. This is the case in most countries around the world, with some like Argentina and Turkey standing out with hyperinflation at 55 per cent and 70 per cent, respectively. Our neighbour Sri Lanka has an inflation rate of over 30 per cent.

Demand uptick factor

The main force driving up inflation in Europe has been the rise in energy prices, up by around 26 per cent from last year. Economists have identified the rapid increase in demand following a lull during the pandemic, along with supply chain bottlenecks in China (and its zero-Covid strategy), as the leading causes for the rise in prices. As food and energy prices increase, so does the burden on the French wallet with more households expecting higher prices in the future and spending less now.

Household spending provides a great impulse for economic growth. Low growth coupled with high inflation can cause what is known as stagflation. Low growth leads to unemployment and fall in spending power, while inflation leads to a fall in the value of money; therefore stagflation is definitely a dangerous prospect.

Inflation has been aggravated by the frictions with Russia, a country that Europe depends upon heavily for 40 per cent of its gas supply. Russia and Ukraine are important trade partners for many economies around the world. Russia is the second largest natural gas producer and the third largest oil producer in the world. Moreover, it also commands a great share of the world’s production of steel and aluminium.

The world also depends on these countries for wheat, corn and sunflower oil. The IMF forecasts that due to war-induced supply shocks because of the war, inflation will rise to 5.5 per cent in advanced European nations. It also forecasts a contraction for the French economy for two continuous quarters this year and a fall in real GDP growth from 7 per cent in 2021 to 1.4 per cent in 2023.

Advantage Russia

Efforts to impose sanctions on Russia also seem to have been counterproductive. Though a majority of Russia’s foreign reserves remain frozen and sanctions on the central bank and the use of SWIFT (an interbank messaging network) have brought down imports, it is expected that Russia will have a record trade surplus, which would help it finance the war. This is mainly due to the fact that these are not trade sanctions; sale of oil and gas is still permitted and the rise in energy prices further augments revenues.

Politicians in Europe are rallying to find the best solutions to what is the worst inflationary period since the creation of the euro. Some of the measures taken include reducing energy tax/VAT, and retail price regulation. France, along with some other European nations like Spain and Portugal, has enacted a wholesale price regulation and proposed regulation in windfall profits tax. This is to go with the many cash transfer schemes to vulnerable groups (Macron was re-elected last month with the promise of increasing pensions and food vouchers to 8 million people).

Central banks mainly control inflation using two tools — quantitative tightening, which implies a fall in market liquidity by reducing the assets purchased; or by increasing rates. It is anticipated that the ECB will aggressively raise rates in July and in September (possibly 50 basis points), a first for the central bank in a decade.

India and imported inflation

India too is not immune to this global phenomenon. Rising prices are a worry in India with the most obvious being petrol and diesel prices across States. Food and related products are also costlier. It is to be noted that supply chain disruptions, the consequently higher global commodity prices and energy costs are the major factors behind India’s high CPI levels. It is not demand driven.

Amul, for instance, raised the price of milk by ₹2 a litre recently citing pressure from energy, logistics and packaging costs. The same goes for tea, coffee and Maggi from Nestlé! The government has announced subsidies for gas cylinders, a reduction in Customs and import duties for certain raw materials like steel, and a reduction in excise duty for petrol and diesel.

In line with the standard response to deal with price rises, the RBI finally hiked the repo rate by 40 basis points in May and again most recently in June by 50 basis points after witnessing headline inflation above the upper tolerance levels for four months continuously. This brings the rate to 4.9 per cent (still lower than pre-pandemic levels). The MPC projects inflation to be 6.7 per cent for the fiscal year. ‘Imported’ inflation is our collective lived reality.

The writer is a Masters Student at the Paris School of Economics

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