Pandemic aftermath: global inflation

The COVID-19 pandemic was responsible for unusual supply and demand shocks, which affected different industries, as stated by Deloitte (2022). The advisory company explains that monetary and fiscal authorities responded with massive stimulus packages to assist the companies in the battle against liquidity shortages, bankruptcies, and the need for layoffs. Despite the efforts of governments and central banks, months of suppressed activities and constrained supply during the pandemic have made rising prices one of the biggest challenges facing the global economy (McKinsey, 2022). This essay explores the economic effects of the pandemic, the monetary and fiscal measures adopted by governments that contributed to high inflation, and strategies adopted by central banks to reduce the pressure on prices in the post-pandemic period.

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PwC (2020) explains that the lockdown policies applied during the pandemic as an attempt to reduce the spread of the virus resulted in a supply-chain disruption. According to the organisation, the restrictions imposed by COVID-19 impacted aggregate supply by slowing down manufacturing, reducing people and goods flows, and creating logistical constraints, which pushed the costs up. Rio-Chanona et al. (2020) analysed the economic effects of the pandemic and included the labour supply shocks, influenced by virus infections and business lockdown, as one of the most relevant elements of the supply shocks.

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The complexity of dealing economically with the COVID pandemic was even greater because supply shocks were not the only effect experienced. Maiello (2020) argues that the interdependence of the economy makes the impact of the pandemic negatively affect demand in different sectors[1]. The study performed by Rio-Chanona et al. (2020) indicated that consumers concerned about the risk of infection are less likely to demand products and services involving close contact with other people. The study concludes that, combining supply and demand shocks, the consequence is a reduction in GDP and employment. According to Dyvik (2023) and O’Neil (2023), the global GDP decreased 3.4% in 2020, compared to an increase of 2.9% in 2019, and the global unemployment rate increased from 5.54% in 2019 to 6.9% in 2020. The global inflation reduced from 3.5% in 2019 to 3.2% in 2020 because of the shocks, and in 2022 it peaked at 8.7% (IMF, n.d.).

The concept of multiplier explored by Begg et al. (2020) suggests that countries in which government spending has a higher impact on the overall economy are more affected by periods of recession since they may experience larger aggregate demand changes and usually the interest rates are already low, reducing the ability of central banks to further stimulate economic growth through monetary policies. In Graphs 1 and 2, the shock impact and the GDP change during the pandemic are demonstrated.

[1] For example, the closure of the gym for sanitary purposes reduces the interest of customers in buying sportswear clothes (Maiello, 2020).

Aiming to fight the impacts of the pandemic, governments and central banks adopted several monetary and fiscal initiatives[2]. As part of the fiscal policies, governments provided stimulus checks and loans for poor people and highly impacted industries, subsidies for the development of low-cost vaccines, and deferral of tax payments. Related to monetary policies, Cantú et al. (2021) collected data from 39 economies and identified that one of the first measures adopted by most of their central banks was a reduction in interest rates. Other relevant initiatives included liquidity assistance through lending transactions, asset acquisition programmes, and foreign operations to limit exchange rate volatility.

[2] An analysis performed by the International Monetary Fund (IMF, 2020) demonstrates countries have spent $9 trillion to support people and organisations during the COVID-19 crisis until May 2020.

The monetary and fiscal measures adopted around the world were focused on supporting aggregate demand and avoiding the recession of the economy due to the shocks. However, as stated by Begg et al. (2020), both the increase in government spending and the reduction in interest rates by central banks boost post-pandemic inflation. Soyres, Santacreu, and Young (2022) claim that a slow pace of production adjustment combined with fiscal stimulus to increase consumption of goods and services without any significant influence on the aggregate supply led to an imbalance in the products available on the market and, consequently, inflation.

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The fiscal and monetary policies attempting to recover output have been hit by the global energy shock following Russia's invasion of Ukraine in 2022. This economic phenomenon was explained by Begg et al. (2020) as a temporary supply shock. In this event, the short-run supply curve shifts, increasing prices.

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The effect of the monetary and fiscal policies adopted by governments and central banks on global levels of inflation is presented in Graph 4:

As shown in Graph 5, both advanced and emerging market economies adopted measures to support the recovery of the countries during the pandemic. In the International Monetary Fund (IMF, n.d.) analysis of the policies responses to the pandemic, it is demonstrated, for example, that Brazil, an emerging country, expanded health spending and temporary fund support to vulnerable citizens, lowered taxes on essential medical products, and expanded credit lines in public banks for companies and households. As a monetary policy, the Brazilian central bank reduced the policy rate, the reserve requirements, and slowed down the depreciation of the BRL/USD exchange rate with spot and derivative contract[3]. In the IMF analysis of the United Kingdom (advanced economy), the fiscal policies included ￡48.5 billion of extra funds for the public health system and services, ￡29 billion for supporting businesses, and ￡8 billion for vulnerable people. The fiscal measures also included special credit lines and government support for wage maintenance. The UK monetary policies included a reduction of the bank rate, an increase in national and corporate bonds held by the central bank, special incentives for lending, and the prevention of large banks from making dividend distributions[4].

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[3] Brazilian central bank reduced the policy rate to 2% (4.5% in 2019) and the reserve requirements from 25% to 17% to increase liquidity. In order to slow down the depreciation of the BRL/USD exchange rate, which reduced 40% in the period from the pre-pandemic to the end of 2020, the central bank interviewed about $ 44 billion in spot and derivative contract sales ((IMF, n.d.).

[4] The UK monetary policies included a reduction of the bank rate to 0.1%, an increase of ￡450 billion in the central bank’s holdings of national and corporate bonds, special incentives for lending to small and medium-sized entities, and a reduction of the UK countercyclical capital buffer rate to zero. The Prudential Regulatory Authority (PRA) also prevented large banks from making dividend distributions until the end of 2020 (IMF, n.d.).

[5] “Deviation from projected spending is constructed by calculating the percent change between each government’s fiscal spending in 2020 against a 2020 projected value. The projected value is calculated by taking the average fiscal spending growth rate between 2015-2019 and forecasting out a year. Federal Reserve Board country classifications are used to group countries into Advanced Economy and Emerging Market Economy categories”(FRB, 2022).

Although initiatives during the pandemic demonstrate a much greater resource allocation capacity in the United Kingdom compared to Brazil[6], in the post-pandemic period, the measures to contain inflation are similar. The analysis of the historical interest rates in both Brazil and the United Kingdom demonstrates that the central banks are committed to combating rising prices by increasing the cost of money. In Graph 6, Brazil increases the interest rate first, still in 2021, and at the end of 2023 it will already experience small reductions to control inflation, while in the UK the interest rate increase occurs more slowly.

[6] The total amount of COVID-19 expenditure in FY2020/21 by the UK Government was ￡280 billion (IMF, n.d.), compared to R$ 524 billion spent by the Brazilian Government (Portal da Transparencia, 2021), which, converted using an exchange rate of 6.20 R$/￡, corresponds to ￡85 billion.

The fact is that inflationary pressure is persisting, and, according to the OECD (2023), the interest rates in most of the economies are expected to remain high until 2025, much longer than projected by the markets, demanding rigid fiscal and monetary policies for the long term.

References:

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BACEN (n.d.). Basic Interest Rate - Historical (Online). Available from: https://www.bcb.gov.br/controleinflacao/historicotaxasjuros [Accessed: 4 December 2023]

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Bank of England (2023). Interest Rates and Bank Rate (Online). Available from: https://www.bankofengland.co.uk/monetary-policy/the-interest-rate-bank-rate [Accessed: 4 December 2023]

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Begg, D., Vernasca, G., Dornbusch, R. and Fischer, S. (2020). Economics (Online). McGraw-Hill UK Higher Ed, 1994. Available from: https://ebookcentral.proquest.com/lib/ed/detail.action?docID=6224432 [Accessed: 1 December 2023].

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Cantú, C., Cavallion, P., Fiori, F. and Yetman, J. (2021). A global database on central banks’ monetary responses to Covid-19. BIS Working Papers No 934. (Online). Available from: https://www.bis.org/publ/work934.pdf [Accessed: 3 December 2023]

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Deloitte (2022). The return of inflation (Online). Available from: https://www2.deloitte.com/fi/fi/blog/finland-blog-homepage/2022/the-return-of-inflation.html [Accessed: 1 December 2023]

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Dyvik, Einar H. (2023). Global real Gross Domestic Product (GDP) growth after the coronavirus (COVID-19) from 2019 with a forecast until 2024 (Online). Available from: https://www.statista.com/statistics/1102889/covid-19-forecasted-global-real-gdp-growth/ [Accessed: 3 December 2023]

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IBGE (2023). IBGE - National Consumer Price Index System (Online). Available from: https://www.ibge.gov.br/estatisticas/economicas/precos-e-custos/9256-indice-nacional-de-precos-ao-consumidor-amplo.html?=&t=downloads [Accessed: 30 November 2023].

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IMF (2020). Tracking the $9 Trillion Global Fiscal Support to Fight COVID-19 (Online). Available from: https://www.imf.org/en/Blogs/Articles/2020/05/20/tracking-the-9-trillion-global-fiscal-support-to-fight-covid-19 [Accessed: 3 December 2023]

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IMF (n.d.). Inflation rate, average consumer prices (Online). Available from: https://www.imf.org/external/datamapper/PCPIPCH@WEO/WEOWORLD/VEN [Accessed: 7 December 2023]

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International Monetary Fund (n.d.). Policy Responses to COVID-19 (Online). Available from: https://www.bcb.gov.br/controleinflacao/historicotaxasjuros [Accessed: 4 December 2023]

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Maiello (2020). How COVID-19 Shocked both Supply and Demand. Chicago Booth Review (Online). Available from: https://www.chicagobooth.edu/review/how-covid-19-shocked-both-supply-demand [Accessed: 3 December 2023]

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McKinsey (2022). How business operations can respond to price increases: A CEO guide (Online). Available from: https://www.mckinsey.com/capabilities/operations/our-insights/how-business-operations-can-respond-to-price-increases-a-ceo-guide [Accessed: 1 December 2023]

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O’Neill, Aaron (2023). Global unemployment rate from 2003 to 2022 (Online). Available from: https://www.statista.com/statistics/279777/global-unemployment-rate/ [Accessed: 3 December 2023]

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OECD (2023). Economic outlook: A mild slowdown in 2024 and slightly improved growth in 2025 (Online). Available from: https://www.oecd.org/newsroom/economic-outlook-a-mild-slowdown-in-2024-and-slightly-improved-growth-in-2025.htm#:~:text=Source%3A%20OECD%20Economic%20Outlook%2C%20November,policy%20is%20expected%20to%20ease [Accessed: 5 December 2023]

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Portal da Transparencia (2021). Federal resources allocated to combat the CORONAVIRUS (COVID-19) pandemic (Online). Available from: https://portaldatransparencia.gov.br/coronavirus?ano=2020 [Accessed: 4 December 2023]

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PwC (2022). Impact of COVID-19 on the supply chain industry (Online). Available from: https://www.pwc.com/ng/en/assets/pdf/impact-of-covid19-the-supply-chain-industry.pdf [Accessed: 3 December 2023]

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R Maria del Rio-Chanona, Penny Mealy, Anton Pichler, Fran?ois Lafond, J Doyne Farmer (2020). Supply and demand shocks in the COVID-19 pandemic: an industry and occupation perspective, Oxford Review of Economic Policy, Volume 36 (Online). Available from: https://doi.org/10.1093/oxrep/graa033 [Accessed: 3 December 2023]

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Soyres, F., Santacreu, A. M., Young, H. (2022). Fiscal policy and excess inflation during Covid-19: a cross-country view. Federal Reserve Board (Online). Available from: https://www.federalreserve.gov/econres/notes/feds-notes/fiscal-policy-and-excess-inflation-during-covid-19-a-cross-country-view-20220715.html [Accessed: 3 December 2023]

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Richter, Felix (2020). Coronavirus Wreaks Havoc on Economic Growth Prospects (Online). Statista. Available from: https://www.statista.com/chart/21942/revisions-to-gdp-growth-forecasts-due-to-coronavirus/ [Accessed: 8 December 2023]