Persistent inflation is keeping the global economy in suspense. Driven, among other things, by the Corona crisis, inflation is increasingly causing worried expressions – by now no longer just for stockbrokers and bankers. According to an estimate by the German Federal Statistical Office, the inflation in November was at 5.2 percent, the highest it has been in 29 years. On a global level, too, experts expect inflation to rise over the long term.
Low prices in previous year as cause of inflation
The German State Statistical Offices provide details and specifics about the current situation. For example, the State Statistics Office in Rhineland-Palatinate blames a number of reasons for the high inflation rate. These include the low prices in the previous year; above all the low price level for mineral oil products and the regular VAT rates, which have been in effect again since the beginning of 2021 after they have been lowered because of the pandemic in the previous year. Further price increases were the result of the introduction of CO2 pricing in January 2021 as well as pandemic-related effects.
Energy prices with the highest rate of inflation
The causes for the rise in inflation are usually manifold, but can be differentiated based on their origin: Global vs. local causes. The German state of Rhineland-Palatinate serves as an example here. There, energy prices have risen by 22.5 percent compared to the previous year. Mineral oil products (51.9 percent) and heating oil (60.8 percent) were particularly affected. Fuel prices rose by 43.4 percent. In the food sector, prices for edible oils and fats in particular rose (11.2 percent). There was also a noticeable price increase for dairy products (6.8 percent) and eggs (14.8 percent).
The role of the central banks
In light of the current situation in Europe, there are increasing calls for the "guardian of the currency," the European Central Bank (ECB), to raise interest rates. At the European level, the ECB has the function that otherwise state central banks have at the national level: To ensure a stable currency, i.e. a low inflation rate. Ensuring this price stability is a top priority for the ECB. The demanded increase in interest rates would encourage people to save and invest money instead of using it for consumer spending. This would reduce the amount of money in circulation, which would lower inflation. However, it appears that the ECB is sticking to its low interest rate policy. The goal behind this is to stimulate the economy through cheap money in order to counteract a recession - caused by the Corona crisis.
In an interview with the Frankfurter Allgemeine Sonntagszeitung, ECB President Christine Lagarde affirmed that the increased inflation rates were only temporary and would recover in the next year.
Inflation and crises
A look at the past shows that excessive inflation and crises are closely related. The question arises as to which of the two comes first. Countries whose politicians decide on the country's monetary policy are subject to the temptation to print more money to finance their projects. In the past, this has been particularly observable in times of war. In the summer of 1914, when all signs in Europe pointed to war, the government of the German Empire dissolved the link between the Deutsche Mark and the gold standard, which meant that money could be printed unchecked again. Among other things, bonds were used to cover banknotes. The money supply quintupled within four years. Financing almost always takes place at the expense of the population, because inflation destroys their wealth and, in the worst case, causes high poverty rates and mass emigration. One example of this is the ongoing economic crisis in Venezuela.
At the same time, the opposite scenario is also conceivable: That inflation exacerbates an already existing crisis. After all, it is primarily the people who suffer from inflation, and if, for example, food prices rise during a crisis and people cannot afford basic food due to inflation, unrest and revolts quickly ensue.
When high inflation is compounded by other indicators of poor governance, such as a deterioration in the supply situation, this can greatly increase the risk of subversion and rebellion. Some analysts see this combination as the root cause of the outbreak of the Arab Spring and the civil war in Syria.
Based on the experience outlined above, countries whose central banks do not act independently of the government are viewed particularly critically. A current example of this is Turkey.
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At CONIAS, we focus not only on political and sociodemographic indicators, but also on economic factors. Along with other methods, these form a framework that we use to analyze and predict political risks.
About the authors:
Lars Klöffer & Dr. Nicolas Schwank
CONIAS Risk Intelligence
Michael Bauer International GmbH