It’s not so much prices, but price expectations, that matter, writes Peter Hall. Read on.
Like today, prices back then were pretty tame for over a decade before inflation hit in the early 1970s. At that point, prices accelerated rapidly due to sustained strong demand, and vaulted into double-digits with the oil price shocks. The impact was quite sudden, and took a long time to subside. This time around, a 31-year run of programmed price stability was not enough to counter a sharp run up in prices.
Why? Well, it began with specific prices. The pandemic interrupted a finely tuned, pan-global logistics network by hitting different countries at different times. It wasn’t initially a problem, as global consumption also fell. But when the economy started firing again, many products simply couldn’t keep pace — think energy, other commodities and semiconductors. The Russia-Ukraine conflict further constrained energy supply while adding food to the mix.
Initially, central banks waved it off, expecting that bottlenecks would be temporary and that prices would soon calm down. Clearly, that didn’t happen. In fact, as the weeks passed, inflation’s reach rapidly spread to a much wider range of goods and services; it was no longer just the volatile, non-core elements of the price indexes that were misbehaving. It gets particularly complicated when goods that are used in just about everything are in short supply.
At that point, a more generalized inflation is almost unavoidable and reining things in becomes a lot more complicated. Shortages, real or rumoured, create a rush of extra demand and a willingness to pay the asking price. Suddenly, price sensitivity isn’t as great and prices are determined by what the market will bear. This is where price expectations, anchored for decades, become unhinged.
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