Inflation Is Taking Hold Worldwide. Where Is It Hitting The Hardest?

The central theses

  • Many factors have led to the high rate of inflation that the world is experiencing.
  • Many countries are experiencing high inflation, some approaching the 10% mark.
  • Higher interest rates are the most important tool to combat inflation, but they take time to have an impact.

US consumers have struggled with rising inflation for almost a year. However, many of us fail to consider the global impact of inflation and how it affects different parts of the world differently.

The US Federal Reserve is aggressively raising interest rates in Germany in response to rising inflation. Central banks around the world are taking similar action. Let’s take a closer look at how we got here, where inflation is hitting hardest, and what other countries are doing to limit the damage.

How did we get high inflation?

The inflation we are witnessing today has its origins in various factors, such as:

  • government spending
  • COVID-19
  • problems in the supply chain
  • Higher Salaries
  • Strong consumer demand
  • Slow political reactions
  • Russian invasion of Ukraine.

The most significant factor overall was the pandemic. Countries around the world have been placed in lockdown and borders closed to stem the spread of the disease. This created a ripple effect throughout the supply chain.

This problem was exacerbated by the stimulus money and financial aid that governments were pouring out to citizens. With money to spend, people continued to buy things. With lower inventories but strong demand, prices naturally went up. Prices have been pushed even higher due to the panic buying waves at the beginning of the pandemic.

When states reopened in the US, businesses needed workers. In view of the high number of vacancies, workers could confidently demand higher wages. With higher income comes higher consumer spending (as well as the obvious increase in hiring costs for businesses), which has caused prices to shoot up even more.

Involved in all of this, the Federal Reserve has been slow to respond to these economic forces. The Fed repeatedly said inflation during the pandemic was temporary and would pass quickly, and decided not to hike interest rates. Because money was cheap to borrow, businesses and consumers continued to spend. The result was runaway inflation at levels not seen in the US in 40 years.

Finally, the Russia-Ukraine conflict led to an increase in energy and food prices. While energy prices have retreated from their peaks, food prices continue to rise as Ukraine – known as the breadbasket of Europe – remains cut off from its usual land and sea shipping routes.

The same story plays out worldwide with some variations. Countries are facing record inflation and are now trying to catch up to slow it down. They walk a fine line between being too aggressive and pushing their economies into recession and not doing enough to contain inflation sufficiently.

Many experts believe that the US will soon enter a recession and many others are warning of a global recession. Currently, 80% of major economies are experiencing a slowdown in gross domestic product.

The good news is that most experts don’t expect a deep recession like in 2008 when the real estate market collapsed. Instead, they expect this recession to be mild and prolonged. With a deepening global recession, investors can expect subpar stock market returns, high unemployment, flat wage growth and weak consumer demand.

Where is inflation worst?

The worst inflation figures come from Turkey with a consumer price index (or CPI) of 80%. Argentina follows in second place with a rate of 78.5%. These are anomalies, however, as political and currency issues have played a significant role in astronomical inflation in these countries.

Many countries including Sweden, Denmark, Mexico and Brazil are pushing for 10%.

Here are some additional countries alongside their latest CPI numbers:

  • Thailand: 7.9%
  • Taiwan: 2.7%
  • Australia: 6.1%
  • South Korea: 5.7%
  • Canada: 7.6%
  • China: 2.5%
  • Russia: 14.3%

While the definition of inflation is the same around the world, every country differs from the United States. Therefore, it is almost impossible to get a direct comparison between the US and other countries.

Take Turkey for example: one of the main reasons for their high inflation figures is the depreciation of their currency, the lira. Since the US dollar is the world’s reserve currency, it is much more stable. If you look at the inflation rate in Turkey, you will see that from the mid 1970s to early 2003 inflation was in the double digits. In the US, inflation has been largely under control since the early 1980s.

At the other end of the spectrum is the UK with inflation hovering around 10%. This is due to the effects of the pandemic on the supply chain and high oil prices from the Russia-Ukraine conflict. Unlike Turkey, the currency is stable and does not have that much impact.

While 10% inflation seems high, some reports are forecasting that UK inflation will rise to 14% this autumn and reach 18% next year. This is much higher than in the US, where economists estimate the economy has already peaked in inflation.

How do higher interest rates curb inflation?

Higher interest rates slow inflation for several reasons. First, when you raise interest rates, companies borrow less money because debt is now more expensive. As they borrow to fund growth, it’s only natural that growth will slow. This also leads to companies hiring fewer workers, which lowers wage growth and employment.

Likewise, consumers borrow less money to buy new homes and cars when interest rates are high. Instead, they save more because they can get a higher return on their savings.

When you combine these, you have slower demand due to higher interest rates and fewer jobs. This causes prices to fall – or at least not rise. Once US inflation returns to the target rate of 2-3%, the Federal Reserve will work to keep it at that level by lowering interest rates.

How do other countries deal with inflation?

The Federal Reserve is aggressively raising interest rates in the US to cool inflation. Fed Chair Jerome Powell is aiming for a 4-4.5% interest rate, but that depends on future CPI reports and other economic data.

What about other countries? For example, the Bank of England is raising interest rates in the UK to fight inflation. Another tool used by the UK is energy price caps. While these caps limit the amount by which energy prices can rise, they fix the price for six months. This could mean inflation stays high for much longer as high prices are locked in for half the year. There are now talks of changing this price cap to three months to fight inflation.

In Turkey the opposite is happening. They lower interest rates. President Erdogan believes that raising interest rates will increase inflation, not decrease it. Interest rates in Turkey are currently around 13%.

Japan, whose CPI is at 2.6%, is standing firm and not raising interest rates. The country is still facing years of slow economic growth, so the Bank of Japan is nervous about raising interest rates and slowing the economy even further. However, Japan stepped in to prop up the yen, which has depreciated 20% this year alone. The hope is that the cost of imports (including energy) will become more palatable once currency depreciation is halted.

The Bank of Canada is also working to raise interest rates to fight inflation. Most central banks around the world are raising interest rates to fight inflation, but aren’t doing much else. There are few tools to combat inflation, and unfortunately rate hikes take time to take effect.

The final result

Countries around the world are experiencing inflation due to the aftermath of the pandemic and the conflict between Russia and Ukraine. Most central banks use monetary policy to combat inflation – namely rising interest rates – as their main weapon.

The problem is that it takes time for higher interest rates to seep through the economy, and while this strategy may not appear to be working, it may very well be having an effect. Banks walk a fine line between too much intervention and too little; Overly aggressive central banks could inadvertently plunge economies into recession. And nobody wants to deal with a global recession.

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