The federal government is investing billions in relieving the burden on citizens.
(Photo: AP)
Persistent inflation, rising interest rates and the risk of recession are weighing on economic forecasts. In Europe, the specter of stagflation has resurfaced as rising oil, gas and food prices continue to fuel inflation while slowing economic momentum. Central banks face a balancing act as they must raise interest rates to curb inflation. Monetary policy seems to be on the right track at the moment.
Nevertheless, analysts are increasingly sounding the stagflation alarm, reminiscent of the oil crisis in the 1970s. However, the risk of a lasting combination of high inflation and a stagnating economy should not be exaggerated. Global unemployment is still relatively low and labor markets are resilient.
In Europe, where wage growth has not accelerated, the risk of an inflationary wage-price spiral is limited. In the US, with its more decentralized wage formation, things are different – there wages have risen sharply.
We learned from the 1970s the importance of confidence in central banks’ ability to meet inflation targets. Another lesson is that temporary spikes in oil prices matter less than we think.
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But the impact of soaring gas and electricity prices is pushing economies into uncharted waters. Will they last, or will they decline like oil prices? That depends on supply and how effective policies are to reduce demand and encourage the use of alternative energy.
Lena Sellgren is Chief Economist at Business Sweden.
(Photo: Business Sweden)
Should gas supplies to Europe be completely disrupted, the impact could be extreme. State aid, which is intended to protect households and companies from a sudden increase in gas and electricity prices, can depress prices at household level in the short term.
Politicians must not neutralize the effect of interest rate hikes
But because of the purchasing power increased by the aid, the money could increase inflationary pressure in the long term. This creates the danger of a price-stimulus spiral, in which additional expenditure for relief is decided upon in response to price increases. This would drive up prices further and prompt governments to commit to even more government aid.
A fiscal policy that focuses primarily on stimulating the economy can neutralize the effect of interest rate hikes to fight inflation. No one wins in this scenario as interest rates only need to be raised further. So there is no threat of a wage-price spiral, but rather a price-stimulus spiral.
More: Leading institutes expect recession for 2023 and rising inflation