Why inflation is so high and why we have to get used to it

At the request of the House of Representatives, seven top economists give their views on the current extremely high inflation. How we got into it is clear. But how and especially when do we get rid of it?

Why is inflation so high?

Energy

The sharp rise in energy prices is driving inflation enormously, everyone agrees on that. And it’s not just about the sharp rise in gas prices, but also about the oil price. That drives up the energy bill and the fuel receipt, but much more.

Just think: with higher gas prices, growing food from greenhouses also becomes more expensive, and you pay that. And what about the rising transport costs for everything that has to be transported. And yes, you will eventually pay for that too.

Corona

However, the inflation specter has been stirring for some time, and that has everything to do with the recovery from the corona pandemic. “The strong recovery of the economies after the 2020 recession meant that demand for goods and services picked up at a rapid pace. Supply could not keep up with that increase for several reasons,” writes monetary economist Edin Mujagic. With all its consequences.

For example, the price of freight transport by ship from China to Europe exploded, because there was not enough space for all the ordered items. Once the items arrived at the port of destination, the items came to a standstill because the ports could not cope, then European countries face a shortage of many tens of thousands of drivers to bring the items to the destination.

“As a result, transport costs also increased considerably, which was ultimately passed on in the price of products when they hit the stores.”

In the video below, Frederieke Hegger explains why wage increases only make inflation worse:

According to professor of monetary economics Lex Hoogduin, these bottlenecks in the economy are reinforced by all the money that households and companies have hoarded during the crisis, which is now being released. This further boosts demand, causing shortages and further rising prices.

The ECB…

That brings us straight to the next culprit, according to several economists: the European Central Bank (ECB). The ECB pumped an incredible amount of money into the economy long before the pandemic, and has increased it even further during corona.

“The amount of money in the hands of citizens and companies has grown strongly during the corona crisis,” says Hoogduin. That money is now being spent en masse, causing prices to go up.

“If inflation is a fire, then the money supply is the firewood that keeps the fire going,” agrees Mujagic. And the ECB still hasn’t stopped adding firewood, so inflation could last longer than you’d expect based on the occasional causes like corona shortages and high energy prices.

…makes it worse

Professor of monetary economics Sweder van Wijnbergen thinks the ECB is only making things worse now. He notes that the expectation that inflation will not disappear soon is because the ECB continues to stimulate. A consequence of this is that wages are also rising faster because employees also want to maintain their purchasing power. And rising wages are driving, you guessed it, more inflation.

Companies are also letting prices rise faster because they don’t trust the ECB to intervene, Mujagic thinks. “As a result, companies that can absorb a temporary increase in costs without passing it on to the consumer, may do so because the central bank is not ready to force the too high inflation back into the cage.”

How long will inflation last?

It turns out that this question is much more difficult to answer. On the one hand, there are many reasons to believe that things will get better over the course of the year.

That is also the expectation of the ECB, writes, among others, professor of monetary economics Casper de Vries. “The thinking is that supply chains and production processes will return to normal once the pandemic subsides. To the extent that the jump in energy prices is a one-off, it will not push inflation further either.” But according to him it does take a while before the effect of such a jump has fully worked through.

There are also global developments that are causing inflation to continue to rise. Like aging for example. As a result, fewer people will ultimately have to do the work, making labor scarcer and wages rising. That makes things that are made by those people more expensive.

The economists more or less agree that once the major shocks are over, inflation will indeed decrease, but it is very questionable whether it will move towards the desired level of a percent or 2, or not. stays higher.

Reducing production in low-wage countries (deglobalisation), an aging population, the loose ECB policy and the energy transition are often mentioned as factors that keep inflation higher than we would like.

So why does the ECB do (almost) nothing?

Formally, the ECB has only one real goal: to keep inflation stable at around 2 percent. But why don’t they? First, as already mentioned, the ECB expects the current inflation to be temporary and so no intervention would be necessary. Incidentally, something is starting to shift here. After the last meeting of the ECB, the central bank announced that the purchase program is indeed being phased out.

Second, it is highly questionable whether the ECB can really do anything. After all, the high prices for gas and oil will not fall if the ECB pumps less money into the economy.

But the ECB is also stuck, sees Hoogduin, among others. Buying less debt and raising interest rates might curb inflation, but at the same time, there are countries in southern Europe that have an incredibly large debt and have to fear rising interest rates. “As a result, the ECB has ended up in a precarious situation,” said the professor.

“Relatively limited rate hikes with the aim of containing inflation could trigger a financial and economic crisis, including renewed doubts about the sustainability of the euro.” And a new financial crisis in the euro countries is the very last thing we want.

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