Past inflation trends offer decision-makers info to exercise prudence

TANZANIA: RESEARCH suggests that early in the 1970s, the Middle East’s conflict caused oil prices to soar, forcing central banks all over the world to struggle to keep inflation under control. About a year later after the oil price rise, oil prices began to level out and inflation began to decline.

Several nations thought they had stabilised prices and relaxed regulations to boost their economies after the recession, only to witness inflation spike back up.

Could the past happen again as tensions within the Middle East area gain momentum? Oil has a direct impact on homes, manufacturers, and companies that depend on global logistics and transportation networks to reach customers. It is a crucial input for domestic use, production, and transportation, to name a few.

Increased petrol prices may limit discretionary expenditure, which might have a ripple impact on the whole economy.

After Russia invaded Ukraine in 2022, a terms-of-trade shock reminiscent of the 1970s caused global inflation to reach all-time highs. Prices increased because of disruptions to Russian gas and oil supplies compounding issues with the Covid-19 supply chain.

Data analysis of already published reports reveals that prices increased in developed economies at their quickest rate since 1984 while price growth in developing and emerging market nations reached the highest since the 1990s.

With the biggest increase in interest rates in a generation to help, inflation has ultimately begun to decline. Analysis of data from the World Bank and IMF signals that between last year and this year, headline inflation in major economies for instance, the US and most of Europe has dropped from over 10 per cent to less than 5.0 per cent.

For the time being at least, the most recent Middle East conflict has not had a significant effect on oil prices and let us hope it remains like that.

However, it is still too soon to declare triumph over inflation for policymakers. Tanzania is currently experiencing low fuel prices, as reported by EWURA in recent days, but we have not yet adjusted to new importer-pressed prices during these difficult times due to the logistical disruption caused by the Middle East’s smoking tension.

To warn policymakers as we struggle to keep inflation under control, I have chosen to review inflation statistics spanning 54 years. First, learnt from history that inflation never goes away.

Reducing inflation to the level that existed before the initial shock requires years to resolve. Even after five years, a significant number of nations in my case analysis were unable to address inflation shock waves and few nations, it took them an average of three years for inflation to return to levels seen before the shock.

The data also shows that, previously, countries have proclaimed success over inflation and removed regulations too soon once pricing pressures initially decreased.

This was a bad move since inflation quickly reappeared. Ensuing an initial shock, price increases in almost all the nations in my analysis that we’re unable to control inflation witnessed a steep slowdown in the first few years before accelerating again or becoming stuck at a faster pace. Policymakers of today must avoid making the same mistakes as their predecessors.

Despite recent data indicating a welcome slowdown in oil price pressures, for example, central bankers are correct to caution that the struggle against inflation is far from done.

One can be posing a straightforward query. Considering this, how should our policymakers handle ongoing inflation?

Again, history offers some lessons on this. A lot of this might be viewed from many angles. The countries in my sample that were able to effectively control inflation tightened macroeconomic policies in reaction to the inflation shock and, more importantly, kept up this tight stance for several years.

Similarly, countries that failed to control inflation tended to adopt more lax policies and were more prone to alternate between tightening and loosening their policies.

The credibility of policies is also important. Inflation was more likely to be defeated in nations with more securely anchored inflation expectations or in which central banks had previously had greater success keeping inflation low and steady. This conclusion offers some consolation to policymakers of today.

Several nations’ central banks may find it simpler to combat inflation this time around due to the reputation for sound policy that they have established over many years of productive macroeconomic management. Countries might alleviate inflationary pressures sooner than in the past if they put the correct policies in place. It won’t be simple though.

Particularly, the state of the labour market needs careful observation. Real inflation-adjusted salaries for workers have decreased in many nations, and they may need to rise once again to keep up with rising costs. However, if wage growth is excessive, it may contribute to inflation and create harmful wageprice spirals.

Historically, nominal wage growth has been less in nations that have successfully combated inflation. Crucially, since lower nominal pay growth was coupled with slower price increases, this did not result in lower real earnings or a loss of purchasing power.

The lesson here for policymakers is to adapt to labour market trends by keeping an eye on real earnings rather than nominal pay.

Successfully combating inflation also improved a nation’s ability to preserve external stability. Currency pegs had a higher chance of surviving than free-floating currencies, which were less likely to experience severe depreciation.

This does not advocate changing the value of money. Exchange rates, on the other hand, seem to have been supported in part by the government’s ability to combat inflation through tighter monetary policy and increased policy credibility. It’s challenging to combat inflation.

However, it’s critical to acknowledge the advantages of pricing stability. In the past, nations that addressed inflation saw slower short-term economic growth than those that did not. Over the medium and long terms, however, this link reverted. Countries that addressed inflation had better GDP and lower unemployment five years after the inflation shock than ones that let inflation persist.

This finding’s economic implications are obvious. There is a trade-off between lowering inflation and attaining greater growth and less unemployment.

However, once inflation is under control, growth resumes and jobs are produced, so this trade-off is only temporary.

On the other hand, there are costs associated with macroeconomic instability and inefficiency when inflation remains unchecked. If there is significant inflation, these expenses will mount up. As a result, throughout the medium to long term, cumulative welfare losses from unresolved or persistently high inflation predominate. Nations that tolerate prolonged inflation bear a heavier cost in the long run.

The people who should learn from these lessons the most are central bankers, who are at the forefront of the battle against inflation. However, governments must avoid adding to price pressures via lax fiscal policy, which would make the job of monetary authorities more difficult.

Governments should direct assistance to the most disadvantaged citizens, as this will lessen suffering the most, to reduce the inflationary impact of fiscal support during a cost-of-living crisis. Since no two crises are the same, the past can never serve as a flawless guide for the present.

Nevertheless, policymakers today can learn a lot from history. It takes a marathon to beat inflation, not a sprint. Our policymakers on this issue must persist, exhibit policy legitimacy and coherence, and maintain focus on the end goal: macroeconomic stability and more robust growth, which are achieved by bringing inflation back to target.

The current inflation level we are enjoying when compared to neighbours may be temporary if past trends are any indication. It would be prudent for policymakers to delay their celebrations.