The scourge of inflation

Published May 23, 2022, 4:28 AM

by Vince Socco

Aside from election chatter, the other buzz word in business, academic and government circles is inflation. It is a very serious cause of concern especially as it may derail the nascent economic recovery, post pandemic.

In the USA, Bloomberg reported inflation to be running at 7 percent, fast nearing historic highs. In the U.K., inflation rates are at similar levels, if not marginally higher. In Eastern Europe, inflation is well into double digits, running in the mid-teens. Meanwhile, in Asia-Pacific, it is still at 2.5 percent but rising. In the Philippines, we already hit 4.9 percent in April.

Government is scrambling to cope with inflationary pressures. The spike in oil prices is the most compelling and discussions on how to slay the rise are raging – from suspension of the excise taxes on petrol products to re-nationalization of oil companies. Transportation fares have risen. Food prices and electricity costs have surged, too. It is a domino effect that cuts across all sectors of the economy. Indeed, the scourge of inflation is real and it is compelling.

To alleviate the impact to the public, gas subsidies to operators of public utility vehicles and free rides on the mass rapid trains have been implemented. Most recently, minimum labor wages were increased throughout the country to help workers cope with the rise in prices.

Inflation, by definition, is too much money chasing too few goods. At least that is the simplified definition that stuck in my mind from my college years. As a Business Economics graduate, I was not the most attentive student in class. My view of the current state of inflation, therefore, could be rather simplistic.

In my mind, inflation was an accident waiting to happen in the post pandemic period. Why? Because in the government’s attempts to revitalize economic activity, it seems that the rise in consumption seems to have gotten way ahead of the recovery of production. Unfortunately, this led to an imbalance in demand and supply.

One driver of consumption was the fact that the system was very liquid. For one, consumers had cut spending significantly during the lockdowns and were, thus, savings-rich. For another, the Central Bank kept liquidity high by keeping reserve requirements of banks low. This was to make sure that the economy had enough runway to stay afloat during the pandemic. When mobility restrictions were lifted, consumption bolted out of the gates with consumers going on a much ballyhooed revenge-spending spree.

On the contrary, the revival in the supply side was not as rapid. Businesses had to un-mothball their production facilities. More significantly, they had to reconstruct their work forces that were decimated during the pandemic. Rehiring and restarting production lines was at a much slower pace than hoped for. Add to that the supply chain disruptions that COVID spawned due to labor shortages and mobility restrictions. Production, while climbing, could not keep pace with consumption.

In addition to the imbalance in supply and demand, the situation was further exacerbated by the Ukraine-Russia conflict. This sparked a rise in oil prices that, in turn, caused a debilitating rise in costs of production. Shipping costs, for example, rose significantly albeit at a time when booking space on vessels is still extremely difficult due to the surge in exports and imports. Foreign exchange rates were also destabilized due to a rush to safe heavens like the US dollar. The Japan Yen fell to lows of over Yen 130 to a US dollar. The Philippine peso breached P53 to a US dollar at one point.

This combination of demand-pull inflation due to the lack of supply in goods, coupled with the cost-push inflation pressures due to the rise in wages and raw material costs is a truly toxic mix. It is a one-two knockout punch that is wreaking havoc on economies globally and, of course, here in the Philippines.

Factories are running on overtime to catch up with production. Unfortunately, supply chain disruptions are getting in the way of things. And the protracted nature of the Ukraine conflict is further fanning the flames of production cost increases.

The new government will have to deal with this overheated situation squarely when it takes office. Monetary policy will be front and center. 

They will now have to delicately balance the taming of inflation with the desire to fuel economic recovery.

In the first quarter of the year, government announced a GDP growth of 8.3 percent, the highest in the ASEAN region. This is a very welcome report, indeed. As we look ahead, we may have to be prepared to pay a little extra for a sustained growth in our economy.

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