University of Hertfordshire Assignment Help on Global Economy

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Global Economy Assignment – University of Hertfordshire

Essay on Inflation | Global Economy

The COVID-19 pandemic has brought back inflation concerns. Inflation can be termed as the rise in the price of products and services with time. More accurately, it is the state of rising price levels. The sudden surge in prices cannot be termed as inflation but the sustained rise in prices is known as inflation (Pangannavar, 2014). It depends on numerous other factors as well like fiscal policies, supply-demand patterns, production and housing costs, etc. Due to its intricate nature, it is difficult to identify inflation. Forecasting and understanding of this phenomenon is, however, important for maintaining the economy. The Euro area, the UK and the US are witnessing low rates of inflation. This essay will identify factors contributing to the low inflation rate in the aforementioned areas. The role of monetary and fiscal policies will be examined towards the cause of preserving the economy.

The Federal Open Market Committee (FOMC) suggests that to attain stability in prices and to achieve maximum employment in the longer run, inflation of 2% should be maintained (Board of Governors of the Federal Reserve System, 2021). However, as evident from Table 1 below, the inflation rate for February for the United States, the United Kingdom, and the European region is significantly less. A gradual increase in the inflation rate is observed in the following months. The inflation rate for the United States increased to 4.2% in April, thereby witnessing a surge (1.6% in March). This big leap in consumer prices was supported by a low employment rate of 6.1% (Statista, 2021). UK inflation rate also doubled in April to 1.5%. Temporary VAT on the hospitality of 5% which is bound to last till September 2021 is one of the reasons behind this low inflation rate (HM Revenue & Customs, 2021). 

Table 1: Inflation rates for the year 2021 (Values are in percentage) Source: (Eurostat, 2021), (Office for National Statistics, 2021), (U.S. Bureau of Labor Statistics, 2021)

A moderate inflation rate boosts the economy. Whereas, low inflation rates are not good and hence must be monitored. If a country has a low inflation rate over some time, it might signify the lack of ability of the monetary authority to keep inflation under control. Also, continuous low inflation risks the chances of hitting deflation. Deflation is the opposite of inflation i.e., it’s the stage that implies a fall in the prices of goods and services. Deflation is considered an economic issue that can escalate recession. 

Several factors contribute to the low inflation. One of them is unemployment. As per Philip’s curve, low unemployment boosts inflation whereas inflation is decreased due to higher unemployment. With the advent of time, economists modified the policy by including energy prices as also a factor (Siok Kun Sek, 2015). As oil prices increase, inflation increases. During the COVID-19 times, a fall in oil prices was witnessed which led to lower inflation. Another factor that restrains inflation is globalization. It has decreased the dependence on domestic factors in accounting for inflation while the role of global resource utilization has amplified (Civelli, 2015). This implies that the apparent calculation for Philip’s curve using U.S. variables won’t yield realistic and accurate results. Technology also plays an important role in curbing inflation. For instance, due to e-commerce, prices of all products are available online, and comparing prices is just a few fingertips away. 

Hence, there is greater price transparency and more competition thus restricting price increases. Moreover, modifications in the labour markets over the period like declining unionization, expansion of the global supply chain, decrease in the minimum wage, etc. may also have been holding down inflation. Other crucial factors determined as the reasons for low inflation are the aging population and excessive savings. For instance, Japan has a greater dependency on the old-age population and hence has one of the lowest rates of inflation (Marie E. Canon, 2015). Economists Ippei Fujiwara and Shigeru Fujita also establish a relationship between inflation and the aging of the labor force in their study (Shigeru Fujita, 2015). They argue that the entry of the old age population to entry-level jobs puts pressure on the younger population’s wages. 

A low inflation rate has adverse effects on the economy. With a high unemployment rate and lower consumer confidence, people refrain from investing and limit their expenditures. A persistently low inflation rate also limits the scope of monetary policies (Kohn, 2006). Low interest rates and zero lower bound (interest rate cannot drop below 0%), confine the scope for the Federal Reserve to further decrease interest rates when the economy is frail (Martin, 2015). A low inflation rate also impacts the functioning of banks. Financial institutions earn from the gap between the income from lending and the cost of borrowing. This gap gets compressed due to lower interest rates that get escorted along with lower inflation.

The question that arises next is whether this low inflation can be ignited using monetary and fiscal policies. During the pandemic, countries all across the globe started fiscal stimulus programs along with substantial monetary support. The US decided upon the stimulus of $1.9 trillion whereas Europe’s stimulus is £750 billion (Sandhu, 2021). This is a huge risk and if it works, it will represent a paradigm shift in economic management. However, the failure in its management will result in high inflation, overheating, financial instability, etc. After the Great Financial Crisis in 2020, nations had considerably more room for lower unemployment and economic growth before there was any inflationary pressing factor. In the US, the unemployment rate tumbled to 3.5 percent in mid-2020 preceding the pandemic, its lowest in 50 years, with no indication of rising inflation (Statista, 2021). In Europe, the ECB battled to raise expansion near its 2% objective, driving numerous to think that there was a lack of financial boost. Essentially, in the UK there has been a colossal infusion of cash into the economy through monetary policies with no indication of expansion whatsoever. This suggests that economies are working below a level, thereby, keeping inflation stable. The National Institute of Economic and Social Research (NIESR) after analysis suggested that inflation had reached a turning point and that an increase to 2.5% can be observed in inflation by the end of 2021 (Boshoff, et al., 2021). Also, as evident from Table 1 above, a gradually increasing trend can be observed in the inflation rates of the countries. However, the next question that arises is whether this increased inflation rate is sustained or just temporary.

Many factors like globalization, aging population, unemployment, technological advancements, etc. contribute towards pushing down inflation. COVID-19 also impacted the economic condition of countries across the world and hence monetary policies were defined to stabilise the economy. The majority of the developed nations like the US, the UK, etc. are facing the issue of low inflation. However, a gradual increase in the inflation rate is observed. Fiscal stimulus programs launched with monetary support have helped countries to alleviate the economic slowdowns. Hence, it can be safely concluded that the US, the UK, and the European region will manage to rise out of their low inflation spree.

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References

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Boshoff, J. et al., 2021. Global Economic Outlook February 2021: The World in its Grip: Covid-19. NIESR, London, 1(B), p. 20.

Civelli, F. B. a. A., 2015. Globalization and Inflation: Evidence from a Time-Varying VAR. Review of Economic Dynamics, 18(2), pp. 406-439.

Eurostat, 2021. Harmonised Index of Consumer Prices (HICP) — Overview. [Online]
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HM Revenue & Customs, 2021. VAT: reduced rate for hospitality, holiday accommodation and attractions. [Online]
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Marie E. Canon, M. K. a. M. R., 2015. Aging and the Economy: The Japanese Experience. The Regional Economist, 23(4), pp. 12-13.

Martin, F. M., 2015. Debt, Inflation and Central Bank Independence. European Economic Review, Volume 79, pp. 129-150.

Office for national statistics, 2021. Consumer price inflation, UK. [Online]
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Pangannavar, D. A. Y., 2014. Manipulation Theory of Inflation: A Research Study on Components of General Price Rise. PRAGATI Journal of Indian Economy, 1(2), pp. 66-82.

Sandhu, M., 2021. US stimulus package leaves Europe standing in the dust. [Online]
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Shigeru Fujita, I. F., 2015. Aging and Declining Trends in the Real Interest Rate and Inflation: Japanese Experience. -Unpublished-, p. 34.

Siok Kun Sek, X. Q. T. a. Y. N. W., 2015. A Comparative Study on the Effects of Oil Price Changes on Inflation. Procedia Economics and Finance, Volume 26, p. 630 – 636.

Statista, 2021. Monthly unemployment rate in the United States from May 2020 to May 2021. [Online]
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