Penned By Rajdeep Sil & Shelly Singh
A lot has happened over the last couple of years. It is no surprise that Covid has created havoc in the lives of the people and the economy. A series of lockdowns has disrupted the entire economic cycle, which can be seen in the rising prices. The following sections will discuss how an unpredictable event has caused disruptions in almost all major economies of the world.
Let us begin by analysing the economic situation of the world’s most influential economy – the USA. In the current situation, the cost of food and other essential commodities is seeing a steep upward trend, with inflation striking 6.2% in October 2021 as per the report in the World Street Journal, which is the highest mark in nearly three decades. At the same time, the Consumer-Price Index (CPI) also rose by 6.2% in October compared to a similar time in the previous year.
While the above data was only about the USA, a similar trend is observed globally.
Here we have compiled the inflation data obtained for some of the major economies of the G20 cohort.
Therefore, as can be observed from the graph above, the significant economies hit are the USA and Germany. Nevertheless, why is the world economy reeling under rising inflation even as the covid pandemic seems to subside?
Before analysing the reason behind a global surge in inflation rates, let us look at some basic definitions.
To put it simply, inflation is the rate of increase in the general price level of any economic system. One of the methods of calculating this is by comparing the price of certain goods and commodities like food, energy and fuel each year. In other words, it can be understood as the decline of purchasing power of a given currency over time; that is, a unit of currency will buy less than it did in the previous years when there is rising inflation.
Will it be good for the economy to have a 0% inflation rate?
Well, truth be told, low to moderate inflation is a necessary factor for economic growth. A certain level of inflation drives consumption which is necessary for creating opportunities and driving growth. Even the RBI states that a 4% inflation is healthy inflation in the Indian context.
Having discussed that inflation is mainly caused due to the rise in prices of commodities, now there are two ways by which prices tend to increase, which leads to 2 types of inflation.
This arises when, cost of supplying the product increases, and the institution passes the increase in cost to the customer, thus raising the prices.
This arises when there is a rising gap between supply and demand. Currently, the global economy is facing this kind of inflation, in which there is rising demand compared to the falling supply. Thus, this supply-demand mismatch is driving up the prices, thus contributing to inflation. To analyse this Demand-pull inflation, we study the factors from both the Demand side as well as the Supply-side, which are the main factors.
So, broadly in this part, we discuss the rise in demand, causing the prices to rise. Now the primary factor responsible for the increase in demand is the availability of more money in the public’s hands. Two significant sources of increase in the money supply are :
Decrease in Interest Rates
If the interest rates are reduced, this encourages more lending and leads to the increased money supply in the market, which increases the purchasing power, and as a result, the demand is increased.
Given the hardships faced by the industry and the small businesses, the Government of India announced a relief package of 6.29 lakh crore, whose sole purpose was to stimulate the sluggish demand that was caused due to Covid-19. Although the demand increased due to the sudden increase in demand, and existing restrictions that hampered the entire supply chain, a huge gap was created in the supply and demand, which led to the rise in prices and ultimately contributed to inflation.
The surge in inflation can be traced back to crunches in supply, amalgamating various imbalances in the economy in which Covid-19 had played a significant role.
Semiconductor Chip Shortage
The supply crunch in the semiconductor industry has been a significant factor in fueling inflation. Semiconductors or chips are among the various electrical components used in manufacturing digital products. They are the life of production when it comes to the digital world. The global move to a distant lifestyle at the outset of the pandemic resulted in a dramatic spike in chip demand. The shift in demand began in the consumer electronics business when families outfitted their houses with enough equipment to continue studying, working, and socialising remotely. Moreover, the economic recovery outperformed predictions in the following months, and durable items such as autos and household appliances saw an increase in demand. Along with rising consumer demand, there was a significant increase in demand for semiconductors required to keep the factory running.
As demand for chips soared, it became clear that vendors could not keep up. Before the pandemic, semiconductor manufacturing facilities, called fabs, were already virtually at total capacity and could not boost output. Many fabs had altered production lines to focus on developing current, bleeding edge chips and could not meet the demand for the simpler, commoditised chips used in autos and appliances. In addition to this, the lack of diversification in the manufacturing fabs of the chips made matters worse. Almost 87% of the chips are produced in China, Taiwan, and South Korea.
With the restrictions of the lockdown being imposed, many factories and industries shut down, as a result, many workers were laid off. Furthermore, surprisingly, when the factories started opening up, these workers were no longer found. Why?. The reason being many of these individuals had returned to their native place and found other chores to earn money from without staying far away from home. This created a workers Crisis. As a result, the entire production chain was hit and caused delays in the supply, hence failing to match the growing demand.
Crude Oil Prices
Increasing oil prices has played a significant role in increasing the costs of the transportation industry. As a result, almost all the commodities and products are bearing the brunt of this rise in the form of increased prices.
Effect on Shipping & Transport Industry
As per the UNCTAD(United Nations Conference of Trade & Development), the rise in international shipping costs can increase inflation by 1.5%. Small suppliers usually bear the shipping costs and are less equipped to handle and absorb additional expenses. In the shipping industries as well, due to the worker crisis, the material handling time increased significantly. As a result, the supplier often had to bear the additional cost due to the delay. This cost then percolated through the entire value chain, thus raising prices. Additionally, if the present spike in freight costs continues, import prices will skyrocket, affecting tiny island developing states the hardest. According to a report, global import prices will rise by 11% on average, but tiny island states may experience up to 24% hikes.
Straying away from pandemic driven imbalances, other factors have also pushed our economy into a tornado of inflation. Due to climate change, the destruction of food crops has resulted in global food prices experiencing inflation. According to an estimate, nearly 30% of the crops in India have been destroyed due to recurring floods.
The inflation that our economy is encountering is demand-pull inflation, wherein the excess demand causes the prices to rise. Policymakers usually term this type of inflation as good as it is, at least in their hands to curb it. However, before inflation gets better, it will get worse, at least for the consumers, as the brunt of the increase in household commodities will be hard to absorb. To curb this rising inflation, the most preferred solution will be for the Central Banks to increase the interest rates to reduce the money supply in the market, which will eventually reduce demand, thus facilitating the match of the demand with the reduced supply to bring inflation under control. However, it is to be noted that the rise in interest rates can hinder the growth story due to the reduced availability of credit; thus, the government needs to create initiatives to ramp up the supply to meet the increased demand and bring the economy back on track.
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