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The Consumer Price Index (CPI) measures the annual change in prices paid by consumers. It is calculated as a weighted average of prices for a basket of goods and services representative of aggregate consumer spending. The CPI is one of the most popular measures of inflation. When the pandemic began, global inflation was decreasing, and the downward trend persisted throughout the early months of the crisis. However, rising costs since late 2020 have progressively driven inflation upward. In September, the Eurozone aggregate inflation rate was at 10%, well above the ECB target of 2%.
The Essence of Capitalism and The Financial Crisis
Prices in a market economy will always rise and fall; if you spend one euro today, it is not the same euro you spent yesterday. Food and energy have been the most significant contributors to high inflation rates since mid-2021. Energy prices are almost 40% higher than a year ago, with a weight of approximately 11% in the consumer basket, implying a total contribution to inflation of more than 4 percentage points. Food and energy prices are determined by global commodity markets rather than Central Banks.
While Central Banks can impact the domestic economy, food and energy are affected by external events such as the war in Ukraine, with Ukraine a major global agricultural product supplier, as well as Russia's halted fuel supply to the West. High energy prices were also caused by resource mismanagement, with prices starting to rise in September 2021 – due to the gas supply not being regulated during the pandemic, resulting in global shortages. Global supply bottlenecks have had long-term impacts on inflation rates, with countries such as China, remaining in a lockdown for much longer. This has since recovered as demand decreased and the supply-demand mismatch narrowed.
Government Intervention: A Solution or The Postponement of The Inevitable
Commodity prices have been falling since the beginning of Spring, which is good news but will lag when it comes to lowering inflation, which is measured year on year. Furthermore, since reaching record highs, gas prices have nearly halved, as demonstrated by future contract pricing. Furthermore, governments around the world are attempting to combat rising inflation through subsidies. Many are attempting to offset the crisis by spending on energy support, with France capping household electricity prices. Global interest rates have also increased in an attempt by Central Banks to counter inflation.
Increasing borrowing costs should deter consumer and business spending, particularly on commonly financed items such as housing. Rising interest rates also hurt asset prices, reversing the wealth effect, and making banks more cautious in lending decisions. The FED began hiking interest rates in March 2022 and already increased rates by 300 basis points. The ECB began hiking later, by 125 basis points so far and is expected to continue aggressively until the end of 2022. The more drastic increases in the US are due to consumer prices being more domestically driven. While the Eurozone is commodity-driven and dependent on external suppliers.
Inflation, Interest Rates, and An Impending Recession
Inflation is forecasted to rise in 2023 but should decrease in 2024, returning close to the ECB’s target. For the average consumer, this means higher bonds and mortgage rates. All while real wages are collapsing — as inflation rises, and wages remain stagnant. While governments try to assist with subsidies, this does not go far enough to bridge the gap created. Consumer confidence has also collapsed, as well as labour market confidence. And while GDP growth in the Eurozone has been strong since the pandemic, a contraction has started, and the Eurozone entered a recession in the 3rd quarter of 2022. This is expected to continue, on a global scale, even though not as widespread as in the Eurozone.
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