Western economies had not recorded such figures for several decades. In December 2021, the inflation rate in the euro zone rose to 5% over one year, unheard of since the creation of the European statistics office Eurostat, in 1997. The same is true across the Channel, where the Inflation is at its highest for thirty years, and even more so in the United States, where consumer prices increased by 7% in 2021, a rate that the country had not seen since 1982.
Several economists, particularly in the United States, are now worried about a lasting rise in prices. While the European Central Bank (ECB) continues to speak of a temporary phenomenon, it has nevertheless raised its inflation forecast for 2022 to 3.2%, twice what it forecast three months ago. Should we be worried about the current situation? Explanations.
How is inflation measured?
Statistical institutes rely on a “basket” of several hundred goods and services consumed by households, ranging from food products to subscription to a streaming platform.
To calculate consumer price index, they perform weightings in this basket, in order to give more weight to the goods and services that are consumed more by households. Energy prices thus have more weight than those of postage stamps (in Europe, they represent 9.5% of the basket). If the resulting price index increases compared to the previous year, it is called inflation. However, this is an average: not all households consume exactly the same products and services in the same proportions, and the rise in prices therefore does not affect them all in the same way.
Each country has its own weightings, but, in the euro zone, a “harmonised” index is calculated in order to be able to compare the figures – hence the different figures between Insee and Eurostat. The inflation rate for the euro zone is itself an average of the rates by country, and hides significant disparities.
Is the current situation exceptional?
If we go back to before the creation of the euro, these 2021 inflation rates are nothing new. In France, for example, it was 10.1% per year on average between the end of the Second World War and the 1980s, according to INSEE. But it was accompanied until the 1970s by sustained growth and low unemployment. The objective of contained inflation is only imposed after the oil shocks and a decade of high unemployment, coupled with a sharp rise in prices.
In the 1990s, this control of prices became one of the convergence criteria with which States had to comply in order to be able to join the European monetary economic union. Today the pillar of the euro zone economy, price stability – and therefore of the currency – is the primary objective of the ECB, enshrined in the Treaty on the Functioning of the European Union.
From 2003, the institution chose to introduce an inflation target “close to, but less than, 2%”, and held it so far. Since the creation of the euro zone, never has a peak such as that recorded in 2021 been observed, not even during the 2008 crisis.
What is the reason for the price increase recorded in 2021?
The inflation rate is calculated in relation to the previous year, but the year 2020 was exceptional. Due to the crisis and the total shutdown of many economies, inflation has been particularly low. In the United States, it plunged from 2.5% in January 2020 to 0.5% in April. Same phenomenon in the euro zone, where prices even fell in the second quarter of 2020.
In 2021, the recovery has been strong and rapid in all economies. Oil prices rose from 20 dollars (17.63 euros) per barrel in April 2020 to more than 85 dollars (75 euros) in October 2021. Due to geopolitical tensions and supply difficulties, gas prices have also experienced dizzying increases, dragging electricity prices down in their wake. According to the President of the ECB, Christine Lagarde, these increases in energy costs explain 50% of inflation in 2021.
Added to this are persistent tensions on the price of raw materials, production and transport capacities. The global economic recovery has come up against major supply difficulties which have generated shortages and therefore, mechanically, price increases. The latter seem all the higher when compared to the abnormally low prices of 2020. If we instead compare the prices of 2021 to those of 2019, we obtain inflation approximately half as much, notes the French Observatory of Economic Conditions (OFCE).
What are the consequences of this return to inflation?
The effects of inflation are not uniform except when it spirals out of control. Often a sign of a growing economy, the corollary of falling unemployment and rising wages, inflation can ease borrowers’ debt, but also discourage saving, generate uncertainty and slow investments, undermining the competitiveness of companies, etc.
If it arouses concern today, it is above all because its first consequence is to reduce the value of the currency and, thereby, to significantly erode the purchasing power of consumers. This phenomenon is observed everywhere in Europe and in the United States, and is felt all the more since the rise in prices concerns above all everyday products, such as energy or food (inflation driven by the prices of cars or technological products, which are purchased more occasionally, are not felt in the same way by citizens).
This effect on purchasing power could be mitigated with wage increases. This is what was done in France until 1983, with salaries, in particular those of civil servants, indexed to the increase in prices. This is no longer the case today. In France, as elsewhere in Europe and the United States, negotiations between unions and employers are multiplying to obtain increases in remuneration which would, at least in part, offset the rise in prices. States are also taking numerous measures to help households financially.
“On a plan of economic balance, we would be completely in favor of wages increasing”, said Christine Lagarde, Thursday, January 19. The latest figures available on wages did not show an increase equivalent to that of prices, and the next ones will be scrutinized closely. While the increases are necessary to avoid impoverishment, economists also fear the creation of a “price-wage loop”: a spiral in which rising prices lead to higher wages, which in turn lead to higher prices, thus fueling inflation.
Will the central banks act to reduce the level of inflation?
The fact that inflation exceeds 2% is not a problem in itself: no intangible mathematical rule asserts that 2% is systematically better for an economy than 3% or 5%. The question is whether the rise in prices is sustainable, and whether it is manageable.
In the United States, the American Federal Reserve (Fed), at the end of 2021, stopped talking about a transitory phenomenon and announced that it would take measures in 2022 to curb inflation, in particular by increasing its key rate – in proportions that have yet to be defined – to curb activity.
However, the American situation is not the same as that of the euro zone. The rise in prices is greater and more diffuse there, and wages are rising, which raises fears of a runaway that would make inflation lasting. The country is also facing a serious shortage of labour, which makes it more difficult for businesses to meet demand boosted by the financial aid distributed to households during the crisis.
In the euro zone, concerns are expressed above all in Germany, where the principles of ordoliberalism, which makes price and currency stability a condition of the economic order, are the foundation of monetary institutions.
But the ECB moved away from the strict 2% target, saying in the summer of 2021 that it was no longer seen as a ceiling. It continues to expect a temporary phenomenon and a return to normal in the course of 2023. According to it, inflation will slow if oil prices stabilize and if supply problems resolve – two factors on which it has not the hand. Predictions are tricky, however. Economists had not anticipated that the production and delivery difficulties would last so long, and it is difficult to say when global economic activity will return to its pre-crisis course, or even if it will return to it. Many are also concerned that energy prices will remain a structural problem in the years to come.
For the time being, the ECB does not plan to intervene by raising its key rates in 2022. “We cannot act immediately. If I raise interest rates, this will have an effect within six to nine months, the time it will go down the financing chain. But we are slowing down growth”, explained the President of the ECB on France Inter. This is indeed the whole dilemma of the central bankers, who do not seem ready to give priority to the strict control of inflation over the preservation of a still fragile economic recovery.