How do we tame inflation without undermining standards of living? By slowing the economy to reduce demand.

 

Inflation makes us poorer.  It does so because the cost of living, as measured by a basket of the necessities of life, increases in price faster than wage growth. It erodes savings, purchasing power and most importantly, confidence. And it has a greater effect on those segments of the population who are least able to cope with it: people on fixed incomes, those who don’t own their own homes and those unable to earn their way to a position that keeps their standard of living at a constant level.

What causes inflation? Essentially, it’s when the demand for goods and services rises at a rate faster than the economy’s ability to supply those goods and services. That imbalance puts pricing power in the hands of producers.

Most of the world has lived through a long period of price stability thanks to globalization. What that means is the growth of supply chains around the world produced huge productivity gains and price competition. In the last several years, the global macro-economic environment has gone through some dramatic change. The root causes of these changes are many. Amongst the most important is the impact of COVID (that, and the economic collapse of 2008/09). In response to the shutting down of many sectors of economic life, governments and central banks around the world poured liquidity into the system. Interest rates were dropped and kept at historically unprecedented low levels. This encouraged a boom in housing and a huge demand for consumer goods. So far, all good.

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