IMF warns Europe against prematurely declaring victory over inflation

IMF warns Europe against prematurely declaring victory over inflation

Subject: Economy

Section: Inflation

• The European Central Bank and other policymakers across Europe need to keep interest rates at current elevated levels until they’re sure inflation is under control despite sluggish growth, the International Monetary Fund (IMF) said on Wednesday, warning against premature celebration as inflation declines from its peak.
• The Washington-based IMF said that the cost of underestimating inflation’s persistence could be painfully high and result in another painful round of rate hikes that could rob the economy of a large chunk of growth.
• The European Central Bank, the Bank of England and the other central banks that aren’t part of the 20-country eurozone are reaching the peak of their interest rate cycles, while some have started to reduce policy rates, the IMF said in its twice-yearly regional economic outlook for Europe. Nonetheless, a prolonged restrictive stance is still necessary to ensure that inflation moves back to target.
• Historically, it takes an average of three years to return inflation to lower levels, while some anti-inflation campaigns have taken even longer, the IMF said.
• While central banks appear to have ended their series of hikes, a failure to finish the job and the resulting return to rate hikes could cost as much as a full percentage point of annual economic output.
• Alfred Kammer, director of the IMF’s Europe department, warned against premature celebration as he spoke to journalists in connection with the outlook. It is less costly to be too tight than too loose with interest-rate policy, Kammer said. The ECB, which halted its rate increases at its October 26 for the first time in over a year, is in a good spot, he said.
• Inflation in the eurozone peaked at 10.6 per cent in October 2022, and has steadily fallen to 2.9 per cent in October.
• The European Central Bank has raised its benchmark deposit rate by fully 4.5 percentage points between July 2022 and September 2023, from minus 0.5 per cent to 4 per cent.
• Higher rates are the typical tool central banks use to control inflation, since higher rates mean higher borrowing costs for consumer purchases and financing new officials and factory equipment. That reduces demand for goods and eases pressure on prices, but can also hurt growth – a difficult tightrope act for the ECB.
• The Bank of England left its benchmark rate unchanged at 5.25 per cent at a policy meeting last week.
• The IMF said Europe was headed for a soft landing after the impact of the rate hikes and did not foresee a recession, while growth forecasts remained uncertain and could turn out better or worse than expected.
• It forecast growth for the region – including the UK and Switzerland as well as the 27-country European Union – of 1.3 per cent this year and 1.5 per cent next year. For the eurozone, the outlook is for 0.7 per cent growth for this year and 1.2 per cent next year.
• If inflation falls faster than expected, it will boost consumer real income and spending and growth might improve. But an escalation of Russia’s war against Ukraine and accompanying increased sanctions and disruptions to trade could mean weaker growth.

Inflation in India

Inflation: Inflation refers to the general increase in prices and the fall in the purchasing power of money. It occurs when the demand for goods and services surpasses their supply, leading to an increase in their prices. High inflation can erode the value of savings and income, leading to reduced consumer spending and economic instability.

Types of inflation include:

• Demand-pull inflation: Caused by increased consumer demand that outpaces supply.
• Cost-push inflation: Caused by an increase in production costs, such as wages or raw materials, leading to higher prices.

Deflation: Deflation is the opposite of inflation and refers to a sustained decrease in the general price level of goods and services. It occurs when the supply of goods exceeds demand, leading to reduced prices. Deflation can discourage spending, as consumers may delay purchases in anticipation of lower prices, which can further slow down economic growth and potentially lead to recession.

Hyperinflation: Hyperinflation is an extremely high and typically accelerating inflation. It occurs when the price levels rise rapidly, eroding the value of the currency. This phenomenon often results from a collapse in the currency and is detrimental to the economy, leading to a loss of confidence in the currency and undermining economic stability.

Stagflation: Stagflation is a situation characterized by a combination of stagnant economic growth, high unemployment, and high inflation. It presents a challenge for policymakers, as traditional measures to stimulate economic growth, such as increasing the money supply, may exacerbate inflation.

Reflation: Reflation is an attempt to stimulate an economy that is experiencing deflation. It involves the implementation of monetary or fiscal policies to increase the money supply and boost aggregate demand, with the aim of reversing deflation and stabilizing prices.

Disinflation refers to a slowdown in the rate of inflation. While prices may still be rising, they are doing so at a slower pace compared to the previous period. Disinflation does not imply a decrease in prices, as is the case with deflation, but rather a reduction in the rate of increase of the general price level in an economy. Disinflation can occur for various reasons, such as increased productivity, reduced consumer demand, or a drop in the prices of commodities.

Core Inflation:

Core inflation represents the long-term trend in the price level and factors out short-term volatility caused by external factors such as energy and food prices. It excludes highly volatile commodities like food and energy, which can undergo rapid price fluctuations due to seasonal and market conditions. By eliminating these volatile elements, core inflation provides a more accurate reflection of the underlying inflationary trends in the economy.

Central banks often use core inflation as a key indicator when formulating monetary policies and making adjustments to interest rates. It allows policymakers to focus on the persistent inflationary pressures in the economy, enabling them to make informed decisions that can maintain price stability and promote sustainable economic growth.

Headline Inflation,

Headline Inflation refers to the complete inflation figure including all goods and services within the consumer price index basket. It encompasses all items, including those that are highly volatile, such as food and energy. Headline inflation is the most commonly reported measure of inflation and is what is typically referenced in the news and by the general public. While headline inflation provides a comprehensive view of the overall price levels, it can be influenced by temporary factors that do not reflect the underlying inflationary pressures.

Types of Inflation:

Demand-pull inflation occurs when aggregate demand surpasses aggregate supply, while cost-push inflation results from reduced aggregate supply due to factors like labor, land, and capital shortages or hoarding.

Factors Causing Inflation:

Demand-side inflation arises from increased consumption, high exports leading to a devalued currency, and excessive money circulation that reduces the purchasing power of money.

Cost-push inflation is influenced by shortages in factors of production and artificial scarcity due to hoarding.

Measurement of Inflation: In India, inflation is primarily measured through two indices: the Wholesale Price Index (WPI) and the Consumer Price Index (CPI), which track changes in wholesale and retail-level prices, respectively.