THE BOTTOM LINE

Does this inflation hurt governments more than consumers?

Bala Shankar

Published Thu, Dec 1, 2022 · 07:00 AM

THE world is bracing for a difficult economic climate for the foreseeable future. Inflation is already at stratospheric levels in most large economies. Tough inflation control measures are being ushered in by central bankers, to the point of inducing some form of recession to rein in demand and prices. But some trends are not obeying this ‘dark clouds’ scenario.

Demand for household goods, travel and vacations, dining and even housing, are either on a normal keel or at elevated levels. Global air travel grew 67 per cent and 57 per cent in August and September 2022, compared to the same months in 2021. Granted it came off a low pandemic base, but it was a huge jump and has pushed up ticket prices. Employment trends in economies like the United States are still robust. The US non-farm payroll data showed a fairly benign unemployment rate of 3.7 per cent for October. Labour shortages are still being reported in many economies. So, is the average citizen immune from the forecasted crash? It would seem so. Who, then, is suffering the brunt of inflation and the impending slowdown? It appears that governments are worrying more about the situation, and rightly so.

Why are citizens not hurting as would be expected? There is a web of reasons – high liquidity hang, massive handouts during the pandemic and even after, income spikes, pent up demand for many things due to the prolonged pandemic, and the explosion of online commerce, are all woven together in the no-holds-barred spending spree. Some psychologists even suggest that a reset of minds may have happened during which people value current experiences over future good times. They should be right as the world veered off the cliff during the pandemic and increased people’s frustration, and doubts about the state of the world. The spending frenzy may not go on forever, but for now, it’s still strong. That adds to the challenges for central banks seeking to dampen demand through interest rate hikes.

The real battle, therefore, lies in government backyards. Their position is unenviable. They seek to rein in spenders and prepare for the rainy day. Governments need tools to tackle the upcoming unemployment surge, manage the growth slowdown that will follow the euphoria, soften the interest rate blow on low-income households, finance the rise in subsidies, cushion the potential housing crash, and possibly also to face election reverses as a result of voter backlash when all the bad news come together. The victory of the far-right in Italy may not be an odd case. Many governments have not helped themselves by running up massive sovereign debt or depleting reserves. US national debt has crossed US$31 trillion, or about 125 per cent of its GDP – a level that once would have triggered red flags for collapsing economies that eventually got IMF bailouts. Debt in UK has spiralled and seems unstoppable, given the double whammy of the Ukraine conflict and post-Brexit blues. To mitigate this, re-engagement with China may have begun too, with economic gains in mind.

The debt and deficit spiral, together with massive financial aid to Ukraine, have also moved governments in a difficult direction – to raise additional resources. That will be a huge challenge in a low-growth environment. Some may find low hanging fruits in taxing the rich more (and some, quixotically, do the opposite) or slashing expenditure (which has its flip side too) or regulating wage spikes for government employees (strikes and election woes await them). Or just do nothing for a while, in the hope that the economic “pandemic” will pass. The whole economic stench has come swiftly and strongly. Forecasters were caught off-guard on many angles – the timing, the magnitude, the solutions, and the aggregate resource crater that the events would create.

Is there a silver lining in all these? A premature end to the Ukraine conflict by worn-down warriors could be a tipping point in the game, should it happen soon. Only one man seems to be able to make this call. Economies like India are doing relatively better, flying under the radar and managing ebbs and flows in domestic demand more astutely. A few other developing economies, including Vietnam and Bangladesh, seem to have suffered less impact and have kept their growth story somewhat intact. As the horses change, it remains to be seen what course the carriage of the world economy will take. Would this also restart labour migration again, to balance the shortfalls and surpluses? Would academics design more all-weather economic models? We should always expect the unexpected. Meanwhile, the citizens are sleeping alright, but governments, not so well.