Overcoming the inflation shock will take time

The world has swung into an inflationary phase it hasn’t seen since the 1970s and 1980s and it will take time to bring it back down, central bankers and economists warned at an ECB seminar in Portugal, which ends on Wednesday.

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– Are we entering an inflationary world?

For the young European Central Bank, responsible for steering the evolution of prices in the euro zone, the current period is unprecedented.

During the Sintra seminar in Portugal, its president Christine Lagarde estimated that the “current levels of inflation in food and industrial products” have reached a scale “not seen since the mid-1980s”.

Likewise, “the increase in the relative price of energy in recent months is well above the individual peaks that occurred in the 1970s” during the first oil shock, she added.

The current price surge, of more than 8% in May in the euro zone, comes after “a sequence in a chaotic world”, explains to AFP Richard Baldwin, professor at the Graduate Institute of Geneva, met in Sintra.

“After the Asian supply shock in 2020 (due to the COVID-19 pandemic), the shift in 2021 from demand for services to demand for goods caused another shock. And instead of seeing that fade away, the Russian invasion of Ukraine was triggered, causing a huge spike in fuel and food prices,” he said.

– Is energy alone involved?

Not only. We also observe that household expenditure on services, as the health restrictions linked to the COVID pandemic are lifted, soar. This can be seen with the boom in tourism and leisure activities, which is also fueling inflation.

Services price inflation hit 3.5% in May, the highest level since the mid-1990s.

This accumulation of such diverse influences is unprecedented. “There is no reference manual for this inflation”, judge Richard Baldwin.

– High prices for long?

While the Russian-Ukrainian war could last “for years”, according to the NATO chief, supply cuts could keep energy prices high.

Alongside imported inflation, domestic factors can also have a lasting impact. Employees are thus increasingly demanding compensation from their employers, which can fuel inflation a little more.

In addition, on the labor market, unemployment rates are rather low on average and hiring intentions high, which works in favor of an increase in wages. And inflation.

– What can central banks do?

Communication is in principle at the heart of their action to control prices.

However, this task “is currently difficult in the face of high inflation figures”, when “people feel high inflation every day when they buy food or go to the gas station, and many suffer from substantial drop in their real incomes”, recognizes Isabel Schnabel, member of the executive board of the ECB, questioned by AFP.

“There is little we can do about current inflation, but we will take decisive action to get inflation back to our medium-term target,” she said.

“Once inflation is there and it begins to raise expectations and wages, monetary policy must act,” warns Şebnem Kalemli-Özcan, a professor at the University of Maryland.

This is what the ECB has planned to do by raising its interest rates from July. At the same time, it must ensure that it does not stifle ever-slowing economic growth.

Because “the question is not whether prices will go down after a while, because they will eventually go down, but what will happen to the growth,” warns Ms. Kalemli-Özcan.

“That’s why some have made the comparison with the 1970s marked by stagflation”, that is to say high inflation and sluggish growth. And to conclude: “In Europe, there is a risk of stagflation.”

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