So About That Inflation Problem...

So we have a pandemic, a war and now inflation. It probably feels like a confluence of horrific events that portend the end-of-times. However, the reality is that inflation is a direct result of the other two and the most likely outcome of combating inflation will be a recession - so there's that to look forward to. The main question now is how bad will that recession be, and how long will it last?

One way to think of the monetary policies adopted by most countries over the last two years is that it was simply 'delaying the pain' of the true underlying weakness in economic output.

It's worth noting that inflation was happening and was going to happen regardless of the war in Ukraine. A couple of things created inflation; flooding the economy with money to try to counteract the effects of the pandemic was a major contributor. One way to think of the monetary policies adopted by most countries over the last two years is that it was simply 'delaying the pain' of the true underlying weaknesses in economic output. While it is difficult to argue that an alternative strategy was available, the bill was eventually going to come due on those strategies, and it was always going to be a reckoning we would have to face at some point. However, flooding the system with money alone could have?potentially?been managed in such a way that we’d have avoided a recession. But, the well publicized global supply chain disruptions increased scarcity of goods to such an extent that when combined with the oversupply of money, it was a recipe for disaster.

Some economists have pointed out that supply chain issues vs. lack of production capacity is a key difference between now and the 1970's. However, this assumes that:

1. The supply chain issues will correct themselves within a reasonable timeframe
2. There will be no further shocks to supply that could prolong scarcity or increase the cost of production

Both of these things are less rosy than we would have hoped. The prolonged 'Zero Covid' policy in China is one example of the faults with assumption number 1. The 2nd assumption is even worse. The shocks to oil prices as a result of the war is the element that makes things a lot scarier. Why? Because it raises the spectre of stagflation, which was kind of a worst of all worlds scenario that North America experienced in the 1970s.

Just a reminder that stagflation = Slow?economic growth?and relatively high unemployment (economic stagnation), accompanied by rising prices (i.e., inflation). Or more simply a period of inflation combined with a decline in GDP. You can also think of Stagflation as a normal recessionary cycle that gets an external shock that keeps inflation high - like the price of oil for example.

The OPEC oil embargo is what triggered stagflation in the 1970s and now it’s the war in Ukraine. The result is unfortunately the same, meaning that increases to interest rates needed to curb demand will now need to be higher and more painful because the actual cost to produce and deliver goods to market has been impacted by oil prices.

How bad was it in the 1970s and 80s? Umm... bad.+

Even by historical standards:

So in summation, here is an incredibly long run-on sentence:

We did some things as a result of the pandemic (and, for arguments sake, for political reasons too), that started the inflationary cycle, which was propelled further by supply chain issues, that is leading to the need to raise interest rates (which have been very low for a very long time by historical standards), which will lead to a recession, which will become stagflation if we don't get oil prices under control (which is due to the war in Ukraine we can't control).

...big breath in...

So about that Inflation problem... The team at Dig Insights has conducted a study about Inflation. How it is affecting people and how they are reacting to it. If you would like a copy of that report, reach out?HERE to download one!

This is the start of a number of articles I will be writing on this topic. If you want to be notified of future articles about the results of our inflation study and what's next for the economy, follow Dig Insights or DM me for more.