Rampant inflation despite appearances

The decline in year-on-year inflation in March is nothing more than a statistical mirage. In reality, the cost of living in the euro area at the end of the month was 0.96% higher than at the end of February. And today the cost of living is almost 15% more expensive than two years ago.

Statistics are sometimes misleading. Eurostat indicates that year-on-year inflation in the Eurozone fell from 8.5% in February to 6.9% in March. What looks like good news is not good news at all. 

In reality, it is a mirage because prices rose by 0.96% in a single month. If the pace of March were to be maintained, the cost of living in a year’s time would be 11.52% more expensive than it is today, when the European Central Bank’s annual target is 2%. Moreover, core inflation, which does not include food, energy, alcohol and tobacco, stood at 5.7%, an all-time high. 

The reason for this apparent contradiction between the decline in year-on-year inflation and the actual increase in inflation during March is the “staggering effect”. With the war in Ukraine, prices soared in March last year mainly due to the cost of energy, which has since been contained. As a result, when comparing the year-on-year price increase in March with that of February, the percentage increase is lower. 

February’s year-on-year inflation includes that huge price increase in March 2022. However, it is no longer included in the March calculation. It is based on the situation on 31 March 2022, after the large price increase had already occurred, and reflects developments between 1 April 2022 and 31 March 2023. 

Runaway inflation

In any case, living in the euro area today is almost 15% more expensive than two years ago. As the economic sluggishness caused by covid-19 was overcome in 2021, the money accumulated during the pandemic restrictions came to the surface and there was an extraordinary increase in demand for goods and services. With supply chains in serious trouble, supply was unable to meet the huge increase in demand and prices began to rise. 

Just when it seemed that the situation might stabilise again, the war in Ukraine triggered a new price escalation, mainly due to tensions in the energy market, but also in other markets. It should be noted that Russia and Ukraine supply the world with a quarter of its wheat, a fifth of its maize and 80 per cent of its sunflower oil. In addition, Russia is one of the world’s leading suppliers of palladium, platinum, titanium and fertilisers, which are essential for agricultural production.

Some experts predicted that inflation would moderate in the second half of 2022. They hoped that the disappearance of extraordinary demand, wage cost containment and rising interest rates would do their job. However, these circumstances have not been enough to bring inflation back to acceptable levels.

Too much money in circulation?

The truth is that central banks have flooded the market with money in recent years to deal with successive crises, which has boosted spending opportunities. And the supply of goods and services has not increased in the same proportion.

As the theory of money supply inflation popularised by the economist Milton Friedman warns, with more money in their pockets, consumers and businesses tend to spend more, so it will be difficult to curb inflation. 

Most forecasts point to a slowdown, but it is not clear that it will occur at the expected pace. For example, the US Federal Reserve expected inflation to peak in 2022 and start falling in 2023, before returning to the 2% target in 2025. And the World Economic Forum estimates that it will fall by more than two percentage points both this year and next.

Higher interest rates by central banks should make a decisive contribution to this. Higher interest rates make borrowing costs less attractive for businesses and consumers, resulting in lower demand and less investment. However, it remains to be seen how far rates can be raised without derailing economies that have been limping for years. 

All the signs are that ordinary citizens will have to continue to foot the bill through inflation for a short-sighted monetary policy, which in recent years has only been able to deal with problems by producing banknotes.

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