What Causes Inflation and Are Banks Worried about It Post COVID?

What Causes Inflation and Are Banks Worried about It Post-COVID

As prices increase, we look at what causes inflation and what banks are expecting from inflation post Covid-19.

The global inflation rate in 2020 reached 3.2%, well above the acceptable rate of 2%. This rise in prices is known as inflation, and this was an issue heavily discussed at the Central Bank Jamboree Conference 2021. It indicates that the prices of most everyday products and services, such as food, clothing and housing, increased, as did their demand due to the pandemic. Often, it results in a decrease in the value of a country’s currency, which then reduces the purchasing power of each unit of currency.

As inflation increases, so does the cost of living. This results in slower economic growth. Small businesses and startups often struggle to cope with the rising prices brought about by inflation. Still, that’s not to say that countries must avoid inflation at all costs. Sometimes, inflation helps encourage expenditure and discourage hoarding, ushering the money back into the economy.

What causes inflation?

From a rise in demand for a product to an increase in government spending—here are some causes of inflation:

1. More demand; less supply

When the pandemic began, we saw people panic-buying huge volumes of everyday items, such as bread and toilet paper. It increased demand for those products. However, the supply struggled to match the demand. This demand-supply gap caused the prices of these everyday items to go up, resulting in inflation. This is known as the “demand-pull” inflation. 

2. Too much money circulating in the economy

When people hoard money or when the population increases, the demand for money rises. Given that, the government has to print more money. As the money supply in the economy increases, its value decreases. That’s because the prices of goods and services go up so that they can keep up with people’s heavier wallets, ushering in inflation.

3. A rise in government spending

Sometimes, governments plan grand infrastructure projects that taxes alone cannot finance. In that case, they often print more money or increase taxes, resulting in inflation.

What do banks expect from inflation?

As per a UBS survey, inflation is among the top concerns for central banks. 57% of the respondents feel that uncontrolled inflation will hamper global economic growth. 

Still, bankers feel that there is not much to worry about just yet. The Head of Strategy and Advice, Global Sovereign Markets, at UBS, Massimiliano Castelli, mentions that though central bankers are expecting a rise in inflation, they don’t think it will move to very high levels. He said, “It seems there is a sort of view among the central banking community that the current rising inflation that we are experiencing is transitory.”

Federal Reserve Bank Chief Jerome H. Powell, in his speech last week, echoed this sentiment. He believes that the central bank of the US, the Federal Reserve, does not need to act just yet because the current inflation might pass. The Chief Executive of Citigroup, Jane Fraser, in an interview with The New York Times, added, “There are many reasons that the peaks we’ll see at the moment will be [transitory]. But what’s the longer-term trend? That, I think, everyone will be keenly watching. We think the jury is out.”

While the consensus is that inflation will be transitory, no one is sure how long it will take to pass. The Dean Emeritus of Columbia Business School Glenn Hubbard believes that the problem with saying that inflation is “transitory” is that there’s no definition there. He illustrates, “I mean, in the eyes of God, my lifespan is temporary. What is transitory?”

How does this relate to startups?

Unlike most bankers, investors are very concerned about the risk of inflation—more than they are about the risk of Covid-19. A Bank of America survey revealed that 37% of the respondents said that inflation was the number one “tail risk” for investors. Globally, citizens, too, consider the pandemic, inflation and supply-chain disruptions to be the top three threats to their countries’ economies. In North America, inflation is the top concern.

Conclusion

Though global inflation is increasing, it is not out of hand yet. According to the World Bank, inflation will remain in the target range for most countries. In an interview, the United States Secretary of the Treasury Janet Yellen said, “Is there a risk of inflation? I think there’s a small risk. And I think it’s manageable.”

Header Image by Unsplash

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