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And after the Coronavirus… Inflation

No, it is not a new strain, but it is the announcement that something like the behavior of inflation that historically has outbreaks, is currently giving symptoms that make our heads, and of course, our pockets, begin to hurt. 

But first of all, what is meant by inflation?

What is inflation?

If we go to the RAE dictionary, its first entry calls it “action and effect of inflation,” and in its fourth entry it defines it as “the generalized increase in prices of goods and services.”

I use both entries in the dictionary because it allows us to mentally visualize the concept. Let me explain: Let's imagine that the prices are a balloon. If we start to inflate a balloon with other people nearby, the first expirations do not pose any problem, but as the plastic becomes tense due to the entry of air, we will begin to observe how those around us begin to change their appearance and worry about how it may affect them if that tension increases. But let's not forget that it would also be worrying if, despite blowing in air, it had a small hole through which it could escape. 

The economic teams of the governments and the Central Banks of all countries are always alert to the price evolution and they periodically publish their behavior through their statistical departments.

In the case of Spain, the National Institute of Statistics periodically reviews the Consumer Price Index, analyzing the price of 479 items in 29,000 establishments distributed throughout the national territory. 

These items (basket of products) are grouped together in various categories to which a weight is assigned, and monthly, annual and interannual variation rates are calculated, which allow us to know if prices are rising or falling.

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Since human beings gave value to what they produced, constant changes in prices have been generated. Furthermore, we must rule out that price increases are always bad, since it has been proven that Interannual CPI rates between 2% and 3%, assume controlled inflation and imply that the economy grows in a “healthy” way, generating employment.

The problem lies when the rise in the CPI is not accompanied by proportional increases in the citizen's income via salary or income, which entails a loss of purchasing power. (A relative, whenever someone talked to him about inflation, resorted to the easy joke that he didn't care since he was going to continue putting 20 euros of gasoline into his vehicle, but of course he didn't consider that he was going to have to go to refuel more times. ).

The same happens with companies that cannot transfer the increase in the costs of production factors to the price of their final products, passing it on to consumers (since doing so would in most cases mean a drop in demand), and they have no choice but to narrow their business margin. The problem becomes more acute when the rise stops being conjunctural and becomes structural.

Now that the volcano on the island of La Palma is so close to us, just as for volcanologists the behavior of earthquakes can anticipate the development of magmatic events, what are economic “vulcanologists” detecting at the moment? Well, all the factors that increase inflation are coinciding in the same time period, which is causing its acceleration worldwide.

Specifically, in Spain we are reaching maximums in the interannual inflation rate of the last 13 years: if in August it was 3.3%, in September it is 4%. And although we all wish it were a simple temporary fever (as some governments believe), neither in Spain nor in the rest of the world is a change in trend predicted, which could lead to it being consolidated over time and becoming structural. :

  • Exacerbated increase in expansive monetary policies by the Central Governments and the American Federal Reserve, with injections of liquidity by purchasing debt issued by public and private sectors, which, although they have allowed interest rates to be kept low, stimulating consumption and investment, have been nourished by tax increases and the exponential increase in the issuance of debt mentioned above. .
  • Current situation of low interest rates, which facilitates access to credit for people and companies, increasing consumption and the level of debt.
  • It is beginning to be detected that some governments, begin to establish price controls on certain products and services, so the companies that produce them are affected and instead of narrowing their margin, they directly stop producing them, even temporarily, generating shortages and bottlenecks.
  • Increase in the cost of production factors: oil, natural gas, steel, wood, copper, etc., which in addition to affecting the price of the final consumer, can also lead to a reduction in supply and therefore to shortages.
  • Uncontrolled rise in demand as a consequence, on the one hand, of the savings generated during the pandemic, and on the other hand, and even more important, also because the consumer prefers to buy now in the face of a clear expectation of an increase in inflation. Demand that, as we have seen, exceeds the supply generation capacity of producers.
  • High spending by governments to maintain the standard of living of those economically affected by the pandemic via subsidies, ERTEs, and an increase in the supply of civil servant positions. 

If the factors/problems that we have just discussed consolidate over time, we could begin to glimpse a scenario of stagflation (coexistence of acceleration of inflation with a decrease in the Gross Domestic Product in more than consecutive quarters), which would paint a panorama even more discouraging if possible, and on which I prefer to turn the page.

Let's go back to inflation. The Nobel Prize in Economics in 1976 and economic advisor to several US presidents, Milton Friedman, proposed as the best possible solution to stop inflation, the reduction of expansive monetary policies by countries, stopping the Central Governments and Federal Reserves from purchasing public debt and raising interest rates. 

This economic theory that might seem like something from the Pleistocene, resurfaces strongly today, and has even been renamed with the term “Tapering”. In all the specialized media we can already see this Anglicism, which to us Spaniards sounds like something similar to “putting the lid on something.”

This solution could be ideal if all economic sectors were growing in this post-pandemic period at the same rate, but not all sectors are growing and not even some have had time to get started. If the stimuli through aid are withdrawn from these sectors or we make it difficult for them to access credit with the increases in interest rates, which the implementation of Tapering entails, we would be imposing a significant brake on them, clearly hindering a hypothetical recovery of GDP. .

In short, returning to what I mentioned in the first paragraph of this post, and contrary to what has happened with the Coronavirus, it seems very difficult to find a vaccine to tackle all the factors that are occurring, and if it is discovered it will be paradoxical. see that what is valid for some countries is not valid for others, and even the side effects it may have are unknown.

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