Blog |  How long will this war inflation last?  The three possible scenarios for the future - Il Fatto Quotidiano

Blog | How long will this war inflation last? The three possible scenarios for the future – Il Fatto Quotidiano

by Mario Pomini *

L’inflation has once again become a prominent economic issue. The cost of the shopping cart has increased in the last year by 9.7%, a value that has not been recorded since 1984. In the last decade, no one was concerned with the extraordinarily modest price increase. In case the problem of European Central Bank it was the opposite: how to stimulate moderate inflation that is always profitable for the business world.

With annual inflation at 8%, the scenario has drastically changed. One of the main effects of inflation is that of reduce real income of consumers. Let’s see some numbers. The Italian GDP in 2020 was 1,653 billion and therefore the net loss for consumers can be estimated at 123 billion. By dividing this sum by the number of families, approximately 26 million, we obtain a reduction in income per family unit of approximately 4,700 euros per year. If we then add to this sum the lack of economic growth compared to forecasts (-4% of GDP), or the increase in the cost of mortgages, we can have a very simplified but effective measure of the high cost of inflation for Italian families. .

The question that many are now asking is whether this inflation it will last a long time or if it is a temporary flare-up. Obviously a lot will depend on the analysis of its causes. Beyond a certain modesty that characterizes the analysis of many commentators, this is essentially a ‘war inflation determined by sanctions that the international community has arranged to punish Russia’s military aggression. Inflation is simply doing its job, signaling the relative scarcity of resources and shifting enormous wealth to some countries, taking it away from others. When will this process stop anarchist redistribution and random of the wealth caused by the war through rising prices’? Looking at economic theory and experience, we can briefly think of two scenarios.

In the first scenario, the optimistic one, the war ends in a short time on the military field or at the negotiating table. At this point, international trade, and above all the commodity market, will restart and the situation will return to a new normal. Prices of raw materials too they will come down by a lot, probably reaching the level of 2021 or even lower. Inflation goes away and maybe there will be one modest deflation with some recovery of purchasing power. In economic terms, the loss of income generated by the war is a temporary event with no long-term consequences. A setback in the economy that quickly recovers.

In the second scenario, the war continues and goes on for a long time, for months and perhaps for years. Here we have to consider two more hypotheses. In the first, let’s call it the liabilities, the consumer accepts the loss of purchasing power generated by the conflict which at this point affects his permanent income. Prices will not rise again, barring exceptional events, but they will not come back either. This final drop in income will have consequences for the economy as it will permanently reduce household spending, but at least inflation will have returned to normal levels. The government can intervene with some temporary intervention to counter the fall in aggregate demand and to support the economy. In summary, in this scenario the consumer pays with one permanent reduction of income the end of inflation.

The second hypothesis in the event of a prolonged conflict is that of the consumer who also turns out to be a producer. We call this the scenario conflictual. In fact, the consumer has a weapon to defend himself from expensive life and that is to ask, as a worker, wage increases at least in step with the rise in prices. We are in the scenario of the seventies, which many commentators fear. Wage increases, if obtained, will result in a further price hike and so on. The economy will be governed by the price-wage spiral with endemic as well as high inflation. Historical experience, however, shows that this path is the most damaging to the economy. Not only are workers rarely able to fully recover lost income, but social inequalities increase because not all categories have the same economic power. The indexation of wages to prices always continues in patches. As is often said, inflation is the most unfair tax because it affects the weakest groups. Inflation, which at this point has become permanent because it is fueled by the redistributive conflict, also leads to a second serious consequence. The Central Bank he will not be watching the devaluation of the currency but it will intervene with the only tool at its disposal, the increase in interest rates. Borrowing for households and businesses will become more expensive and the conditions for one will be created recession economic. This, however, we are already seeing. As a direct consequence of a restrictive monetary policy, public debt, fueled by a high interest rate, will become ungovernable, generating a severe fiscal crisis.

Which of the three cases will come true? On this point, economic analysis is powerless and everything will depend on the choices of the major players in international politics. The economy must inevitably give way to politics because inflation is the other side of the war being played out in the economic field. However, one fact is certain: the economically destructive effects of the Russian-Ukrainian conflict will tend to increase exponentially over the next few months and therefore, if there is nothing new, it is advisable to prepare.

High inflation can have devastating and even unpredictable effects. Just look at the current case of Argentina which has an inflation of 70% per year, carrying almost half of the population below the poverty line. We are still very far from this threshold, but even a stable inflation level of 10% would be difficult to bear – economically and above all socially.

* Prof. associate of political economy, Padua

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