Dealing with inflation

Dealing with inflation

Rising inflation is one of the most vexing issues for consumers, economists and policy makers and is increasing the risk of recession. In this edition of the Horizons, we focus on the answers central banks and governments are formulating to tackle high inflation numbers.

The legacy of an era of quantitative easing

Double-digit inflation numbers combined with interest rate hikes from central banks are challenging citizens, governments and businesses. Key concerns of leading chief economists are the cost of living, uncertain growth outlooks and even social unrest. One aspect of hiking interest rates as a reaction to record inflation numbers, however, is not mentioned that often: the rising costs of unprecedented central bank balance sheets. After the global financial crisis, central banks started buying trillions of dollars of government bonds and mortgage-backed securities to increase the money supply and stimulate economic activity (quantitative easing). Now, with rising interest rates, the costs of reserves on central bank balance sheets are likely to exceed the income from the acquired assets themselves. Already, central banks are warning that their capital position might not be sufficient to absorb future shocks. For instance, the Dutch DNB recently notified the government (their shareholder) that it might need a capital deposit in the future. While certain think tanks have published plans to curb central bank losses, for now it seems that taxpayers will be paying for the trillion-dollar P&L of quantitative easing.

Broaden Your Horizons

  • Tyler Cowen argues European governments, through their price caps, seem to be turning the energy crisis from a “real-economy” crisis into a fiscal crisis. Although this might protect the real economy, bond markets might rebel against continued borrowing, especially as interest rates are rising to combat inflation.
  • This Euractiv article shows that the European ESPR is still challenged by some EU ministers. They expressed their preference for “implementing acts”, which give EU countries a greater say in decision-making.
  • In a previous edition of the Horizons, we discussed the battle between China and the U.S. in the market for semiconductors. This NYT article states that the Biden administration is expected to announce new measures to stop Chinese companies from getting access to American technology.

Preparing for plan B

Many governments are responding to rising inflation with massive financial support. If inflation remains high for a longer time, however, governments will need a plan B. Government debt is already at record heights and rising borrowing costs (a result of increasing interest rates) will reduce the ability of governments to take on more debt. With financial support reaching its limits, societies will be confronted with a prolonged period of higher costs and lower standards of living. To cope, governments will have to come up with long-term strategies that can deal with economic decline and the associated social disappointment. The contours are already becoming visible: in stricter regulation (in the form of price controls), standard setting, and financial reform. Price controls are already discussed and applied, for instance with energy price ceilings or rent controls. Standard setting is also a work in progress; the EU eco-design regulation (ESPR), for example, aims to make durable and sustainable products the norm. Financial reform, meanwhile, is a priority in China’s Common Prosperity Policy with the aim to reduce income inequality and promote people-centered development.

Horizons is a bi-monthly Dasym Research initiative to show you how the Dasym themes have been in the news. We publish the Horizons on our website and as an email newsletter. If you wish to receive the email, sign up here.

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