Inflation affects everyone negatively, but it impacts first and foremost the poorer households. As George Orwell eloquently puts it, “Everyone is equal, but some are more equal than others.” Shocking tales reverberate across Europe conveying the stories of millions of families using credit cards and loans to settle basic bills. What’s more, the ‘horrendous new normal’ pushes for the pauperisation of the working class and many lack sufficient money to pay for food. The crisis has reached unprecedented in the UK, as about half the total of the low-income households regularly go hungry or skip meals. The number increases drastically when it comes to paying for other essentials.
Enter the dilemma – resorting increasingly to mortgages and credit cards to adapt to higher inflation in the face of rising interest rates could lead to spiralling into deeper debt, and the short-term solution spells long-term disaster. Likewise, the inflation’s impact in countries in the West is not uniform – the EU doesn’t seem to enjoy cheap domestic energy, unlike the US, which could dent the adverse effects thanks to the domestic energy market and the dollar gaining strength.
Not surprisingly, though, this is expected – the inflation that the US suffers is on the demand side with an overheated economy, where consumers consume on their savings accumulated during the COVID period. On the other hand, inflation in Europe is mostly cost-push, meaning that higher energy costs constitute a much larger component in the European inflation equilibrium. The energy-related difficulties are not to vanish for Europe – on top of the Russian-Ukrainian war straining the supply chains, the recent oil price surge agreed upon by the oil-importing countries can only provide further volatility.
Still struggling with curbing inflation and as the interest rate hike is the only weapon in its arsenal, the Eurozone has nearly slipped into recession, with a looming contraction in the GDP in the third quarter this year due to the deteriorating dominant services industry, which, in turn, pushes business activity to falter. Each factor is endogenous to the other – as indebted consumers are troubled by increased borrowing fees and high living costs, employers are not keen to boost economic activity, which can even lead to a decrease in labour demand that will result in more unemployment.
When the factors are interlinked, one cannot remain without questioning the policies pursued by the ECB and FED that have more repercussions on the most vulnerable social strata than ever. The recession may be as detrimental as the adversities of inflation on people with low incomes. Indeed, Italian Prime Minister Meloni noted earlier that raising interest rates to counter inflation is too ‘simplistic’ to pursue, and it may be a cure more harmful than the disease. She suggested focusing on measures to control the price of energy and raw materials, i.e., the specific causes triggering this inflation. As the tension deepens, was Meloni right in claiming so?
Meloni was guided by the huge public debts of Italy, where the increase in bond spreads makes it more difficult to finance the debts as the difference in prices rises. But she might be right in advocating for focusing on the root causes. Indeed, previously, Lagarde herself countered the criticisms directed at the ECB for not starting hiking interest rates, saying that rapidly increasing it would not immediately impact energy prices.
In this regard, it is a ‘blunt instrument’ in terms of timing and targeting, where the lag can be up to 18 months for these actions to push the inflation down. Therefore, it largely comes down to the governments addressing the problem by monitoring supply chains and bolstering competition policies to prevent price-fixing and profit-price spirals forged by firms with market power. The latter has been the case with excess demand vs supply imbalances that have encouraged firms to increase price mark-ups over costs and expand profit margins, resulting in greater nominal wage demands and apprehensions for inflation persistence.
Had there been greater control, the complexities could have been avoided. A more holistic approach now should prompt supply-side flexibility, targeted efforts to diminish demand, a political commitment to maintaining energy markets and ensuring cross-border flows, and granting compensation for the most vulnerable consumers.
The hawkish pause observed by Lagarde’s counterpart in the US – Powell, is likely to be undertaken by the ECB shortly as the ECB reaches its peak interest rate after the last decision ending up in a dovish hike. However, the question to be posed now is how soon before the outcome is to the detriment of the overall economy as the alarm bells continue to ring. Inflation targeting is the guiding policy of the central banks, but it may be about time to get rid of the arbitrary 2% figure and instead be more flexible in the approach to avoid collateral damage to society.
Inflation and interest rates point towards a dead end for the lower-income class. Since the EU claims to adhere to social democracy principles, it must rise to the occasion, and protect its most vulnerable citizens.