Jongrim Ha, M. Ayhan Kose, Franziska Ohnsorge 14 July 2021 Global inflation has been on a roller-coaster ride since the beginning of the global recession triggered by the COVID-19 pandemic. The decline in inflation during the 2020 global recession was the most muted and shortest-lived of any of the five global recessions over the past 50 years. The increase in inflation since May 2020 has been faster and sooner than after previous global recessions, including after the 2009 global recession (Figure 1). Looking ahead, as the global economy gradually reopens, monetary and fiscal policies continue to be accommodative to support the global recovery, and pent-up demand may be about to be unleashed in advanced economies. For major advanced economies,
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Jongrim Ha, M. Ayhan Kose, Franziska Ohnsorge 14 July 2021
Global inflation has been on a roller-coaster ride since the beginning of the global recession triggered by the COVID-19 pandemic. The decline in inflation during the 2020 global recession was the most muted and shortest-lived of any of the five global recessions over the past 50 years. The increase in inflation since May 2020 has been faster and sooner than after previous global recessions, including after the 2009 global recession (Figure 1).
Looking ahead, as the global economy gradually reopens, monetary and fiscal policies continue to be accommodative to support the global recovery, and pent-up demand may be about to be unleashed in advanced economies. For major advanced economies, concerns have been raised that the confluence of these factors may generate significant inflationary pressures (Summers 2021, Blanchard 2021). Others, in contrast, see little reason for concern, at least for many advanced economies, because of the temporary nature of price pressures, well-anchored inflation expectations, and structural factors still depressing inflation (Ball et al. 2021, Gopinath 2021, Krugman 2021).
Against this backdrop, in this column we briefly address the following questions:
- What have been the main drivers of recent developments in global inflation?
- What are the prospects for global inflation?
- What are the near-term policy priorities?
Figure 1 Global inflationary pressures
Sources: Haver Analytics, IMF International Financial Statistics, Ha, Kose, and Ohnsorge (2019, 2021a, 2021b).
Note: A. Blue and red lines are medians, dotted lines are interquartile ranges. t=0 is September 2008 for 2009 and January 2020 for 2020; B. Median of year-on-year headline consumer price index (CPI) inflation in a sample of 81 countries, of which 31 are advanced economies and 50 are EMDEs.
Drivers of recent developments in global inflation
The COVID-19 pandemic plunged the global economy into its deepest recession since WWII (World Bank 2021a, 2021b). At the height of the global recession, between January and April 2020, global inflation – defined as median consumer price inflation among 81 countries – declined by 0.9 percentage points amid a collapse in demand and plunging oil prices. Since May 2020, however, global inflation has picked up as oil prices rebounded and demand recovered. By April 2021, global inflation had risen above pre-pandemic levels globally, in advanced economies and in emerging market and developing economies (EMDEs) (Figure 1). This inflation pickup was broad-based, present in four-fifths of countries.
Plunges in aggregate demand, oil price declines, and supply disruptions contributed to global inflation developments during the pandemic. For EMDEs, global shocks were in part channelled into domestic inflation rates through exchange rate movements, compounding the impact of domestic supply shocks as lockdowns disrupted services activity and food supply chains. Larger depreciations, especially during the period of financial market stress in March and April 2020, were a key source of inflationary pressures in EMDEs.
- Plunge in aggregate demand. Lockdowns and weaker consumer confidence triggered a collapse in aggregate demand along with global trade. Global activity reached its trough in mid-2020 and subsequently recovered, supported by unprecedented policy measures (World Bank 2021a, 2021b).
- Oil price collapse. Between late-January and mid-April 2020, amid the pandemic-induced global recession, oil prices plunged by more than 60% as lockdowns disrupted transport and travel, which account for two-thirds of global energy consumption (Wheeler et al. 2020). Oil prices recovered from May onwards and are now near their pre-pandemic level.
- Supply disruptions. Especially early in the pandemic, lockdowns disrupted economic activity, particularly in services sectors. In some countries, especially low-income one, supply disruptions such as market and trade restrictions or curfews appear to have affected domestic food supply chains, increasing wholesale and retail markups and contributing to rising food price inflation (Swinnen and McDermott 2020). We estimate the role of each of these factors in a factor-augmented vector autoregression (FAVAR) model that consists of global inflation, global output growth, and oil prices (Ha et al. 2021a). The results suggest that the decline in global inflation from January-May 2020 was four-fifths driven by the collapse in global demand and one-fifth by plunging oil prices, with some offsetting inflationary pressures from supply disruptions. This contrasts with the 2009 global recession, in which a 13-month decline in global inflation was three-fifths driven by plunging oil prices and only one-third driven by falling global demand. In their rebounds, however, inflation developments after the end of two global recessions resembled each other – both were virtually entirely driven by sharp rebounds in global demand.
Figure 2 Drivers of global inflation
Source: Ha, Kose, and Ohnsorge (2019, 2021a, 2021b), International Monetary Fund, World Bank.
Note: A. CPI = consumer price index; EMDEs = emerging market and developing economies; LICs=low income countries. Cross-country medians unless otherwise specified. Median headline CPI inflation (annual averages) in 12 sectors across 147 countries. Sectors are categorized following the IMF; B. Contributions to changes in year-on-year headline consumer price inflation from the previous month for 81 countries, of which 31 are advanced economies and 50 are EMDEs, based on factor-augmented vector autoregression (FAVAR) estimation. Monthly data. Residual is omitted from the graph.
Prospects for global inflation
Model-based conditional forecasts based on the FAVAR estimation point to a 1.4 percentage point increase in global inflation between 2020 and 2021. For these exercises, global output growth is assumed to be 5.6% and oil prices average $62/bbl in 2021 (World Bank 2021b). Survey-based inflation expectations point to a 1 percentage point increase in 2021 (Figure 3). For virtually all advanced economies and half of inflation-targeting EMDEs, an increase of this magnitude would leave inflation within target ranges. Even for the half of inflation-targeting EMDEs where it would raise inflation above target ranges, this increase may be temporary and would not warrant a monetary policy response as long as inflation expectations remain well-anchored.
Inflation is expected to moderate beyond 2021 as global growth settles at a lower level, commodity prices stabilise, and supply bottlenecks are eased. Long-term expectations also point to continued low and stable inflation. However, several structural forces – such as demographic changes and expanding global supply chains – that have depressed inflation over the past five decades are beginning to fade (Ha et al. 2021b). As they recede, increases in short-term inflation may become more persistent, and thus threaten the anchoring of long-term inflation expectations.
Figure 3 Inflation prospects
Sources: Consensus Economics; IMF World Economic Outlook; Ha, Kose, and Ohnsorge (2019, 2021a , 2021b).
Note: A. Conditional forecast of global inflation based on quarterly factor-augmented VAR model of global inflation, global GDP growth, and oil price growth. Vertical line indicates 16-84 confidence bands; B. Average headline CPI inflation expectations for 2021 based on surveys of May 2021 in 57 countries (31 advanced economies and 26 EMDEs). 2020 indicates actual inflation rates. Yellow whiskers indicate maximum and minimal responses; C. Median five-year-ahead consensus inflation expectations among 24 advanced economies and 23 EMDEs.
Facing growing inflationary pressures, financial market participants may become concerned about persistently higher inflation in advanced economies and may reassess prospects for continued accommodative monetary policies by major central banks. This could trigger a significant rise in risk premia and borrowing costs. EMDEs are particularly vulnerable to such financial market disruptions because of their record high debt and a lagging economic recovery from the pandemic. In the event of financial market stress, sharp exchange rate depreciations and capital outflows may force them to abruptly tighten policies in a manner that could throttle their recoveries. Anchoring inflation expectations will be critical in preserving central banks’ room to manoeuvre even during periods of financial stress.
Even if temporary, higher global inflation may complicate the policy choices of EMDEs in the near term as some of them still rely on highly accommodative policies to ensure a durable recovery. Depending on where they are in the recovery, they need to carefully calibrate their monetary and fiscal policies. For example, in inflation-targeting EMDEs with large economic slack and below-target inflation, monetary easing and fiscal support can help the recovery gain traction and raise inflation towards the target.
In EMDEs where the economic recovery from the pandemic is further advanced, a more nuanced design of monetary policy will likely be necessary. While it may be premature to withdraw monetary and fiscal support, it would be prudent to prepare now for the possibility of future inflation risks materialising, especially those related to sharp movements in foreign currency markets. These economies can embark on an opportunistic build-up of foreign exchange reserves, heighten foreign currency risk monitoring, and strengthen macroprudential policies in anticipation of possible capital outflows once advanced economies begin to withdraw accommodative policies.
Central banks’ responses have been instrumental in dampening the COVID-19 shock (English et al. 2021). Going forward, their communication will be even more closely scrutinised amid concerns over inflationary pressures. To avoid mishaps that could trigger financial stress, central banks will need to clearly communicate their policy objectives and improve transparency (Baldwin and di Mauro 2020). In countries that employ unconventional policies, forward guidance, transparent objectives, and operational details can help maintain investor confidence.
Editor’s note: The findings, interpretations, and conclusions expressed in this column are entirely those of the authors. They do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent.
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