Just finished completing policies for developing countries with my A2 class and invariably with all my economics classes you cannot get away with not talking about the war in Ukraine and the inflationary problems that the global economy is experiencing. The increase in food and and fuel prices hits the developing world the most and could not have come at a worse time as economies around the world are starting to open up after the COVID pandemic. For the developing world, especially in Sub-Saharan Africa (SSA) there is a significant erosion in living standards and macroeconomic imbalances – see graph below. The IMF has identified 3 main areas that the war is impacting countries:
In SSA food accounts for 40% of consumer spending with 85% of wheat supplies being imported. Add to that higher prices for fuel and fertiliser.
Higher oil prices mean adds $19bn to the regions imports which worsen the current account balance. However the eight petroleum exporting countries do benefit.
SSA countries are not well placed to cope with the need for increased government spending which means using more tax revenue. Increasing oil prices have a direct fiscal cost through fuel subsidies and rising interest rates globally make it more expensive to borrow money to keep the economy ‘above water’ let alone for actual development.
Sign up to elearneconomics for multiple choice test questions (many with coloured diagrams and models) and the reasoned answers on inflation. Immediate feedback and tracked results allow students to identify areas of strength and weakness vital for student-centred learning and understanding.
The Inflation globally has been on the increase and above the target band in most developed economies. This applies to both Headline and Core inflation.
Headline Inflation – all goods and services Core Inflation – all goods and services excluding food and energy.
Economic theory suggests that inflation could accelerate and return to levels seen in the 1970’s. A lot will depend how policymakers react to the challenge of bringing inflation down to their specific target level – RBNZ 1-3% but CPI in NZ is 5.9%. See chart for inflation breakdown in OECD countries.
Source: IMF
Key reasons for inflationary pressure.
Supply chain bottlenecks: Lockdowns and shipping problems (container shortages) but latterly the demand side has accelerated – economic recovery and demand for durable goods as well as panic buying.
Demand for more goods than services: Much of the inflation has been in durable goods whilst service inflation has only seen a small increase. This is dependent on which country – for instance demand for used cars in the US has soared.
Fiscal and Monetary stimulus: Approximately US$16.9trn of government spending has been injected into the global economy. This is accompanied by expansionary monetary policy (low interest rates) is conducive to more spending and higher inflation. Savings that accumulated during the lockdowns were now being spent. There was a debate between leading economists whether the inflation would be transitory or persistent. It seems that the data now supports those of the persistent camp. Whether it persists depends on central banks.
Labour supply: Labour participation rates have dropped – for instance for every job opening in the US there is only 0.77 unemployed people per job. See previous post – US Economy – potential for wage-price spiral. This is due to continue meaning that there is a job seekers market where there is likely to be pressure on wages.
Russian invasion of Ukraine: Russia and Ukraine are big exporters of food and major commodities so higher prices have been inevitable with major disruptions to the supply either through sanctions or conflict areas. They supply 30% of global wheat exports so prices have been increasing.
Source: IMF
What should central banks do?
Mainstream policy by central bankers should ignore supply-side shocks like higher commodity prices as this is only temporary. When central banks have intervened and raised interest rates they have ended up worsening economic conditions – ECB raising rates post GFC in 2008 and 2011. Already inflation globally is increasing but there is little central banks can do with higher global energy prices. A focus on home grown inflation (core) might be a better indicator to watch as well as the labour market – fast wage growth might mean higher interest rates. Economist John Cochrane argues that bringing down inflation through higher interest rate is a blunt tool, especially when prices have risen predominately through a loose fiscal policy. He states that inflation might get worse if people doubt the government’s ability to repay its debt without a discount from inflation.
Ultimately the outlook for inflation depends on how determined central banks are to rein in inflation and the confidence of the bond market to governments willingness to pay their debts. Below is a good video from the IMF on the inflationary problem.
This is a useful piece of economic theory which I will be discussing with my classes. After the Russian invasion of Ukraine the Russian currency the Rouble collapsed:
Before the invasions 1 euro = 85 Roubles
After invasion 1 euro = 110 Roubles
After central bank intervention 1 euro = 94 Roubles
This means that it cost post invasion 110 roubles to buy 1 euro, compared to 85 Roubles pre-invasion. The Russian central bank did intervene in the foreign exchange market by using its foreign exchange reserves to buy roubles – demand for roubles goes up. The plan is to sell US$ and euro denomination investments to buy roubles. However a ban on the central bank using swift payments to access reserves overseas has meant that intervention was not an option.
At such low levels the Russian exports are going to bring in less money to ultimately subsidise the war effort. A stronger Rouble will bring in more cash and enhance the image on the country – the value of a country’s currency is a good indicator of how the world views that country.
How will it work?
Putin’s order makes Gazprombank the intermediary in the gas trade. A foreign buyer of gas is required to transfer foreign currency to a special account (so-called K) at Gazprombank. They would then buy roubles on behalf go the gas buyer to transfer roubles to the another special (K) account at Gazprombank – see flow chart.
Why does it matter?
Europe is heavily reliant on Russia for its energy needs, with around 40% of its gas coming from the country. If Moscow decides to turn off the taps it could trigger supply shortages, factory closures and crippling energy costs across the region.
Call in the church to stop the slide in the Rouble
For more on exchange rates view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.
From Al Jazeera – Counting the Cost. Main discussion points:
Ukraine and Russia are expected to experience a severe recession this year. But the sanctions imposed on Russia and the increasing energy price can inflict inflation on other countries.
IMF to cut its growth forecast on the Global Economy.
Russia to turn to the Chinese Yuan to survive and are counties dumping the US$ as the global reserve currency?
Sign up to elearneconomics for multiple choice test questions (many with coloured diagrams and models) and the reasoned answers on Inflation and Exchange Rates. Immediate feedback and tracked results allow students to identify areas of strength and weakness vital for student-centred learning and understanding.
The Financial Times had a good piece about the current state of the global economy and the likeness of the stagflation of the 1970’s. Using that article and other sources I have attempted to differentiate between what was happening then and the current situation with the war in the Ukraine. With oil still having an impact in an economy today this could be the catalyst needed for more greener technologies but this is not going to help in the short-term. Therefore, for global oil prices to stabilise there needs to be an increase in the output of OPEC countries and the likes of Venezuela which could add 400,000 bpd to oil output – the US has been in talks with President Maduro. However, there is a dilemma here in that you may reduce oil prices by getting Venezuela to increase production but you are also assisting an authoritarian regime that is closely linked with Russia.
Sign up to elearneconomics for multiple choice test questions (many with coloured diagrams and models) and the reasoned answers on Inflation. Immediate feedback and tracked results allow students to identify areas of strength and weakness vital for student-centred learning and understanding.
The NZ Parliamentary Library produced some data on the New Zealand’s trade with Russia. The most recent figures for the December 2021 quarter are: Exports of goods and services to Russia – $75 million Imports goods and services from Russia – $14 million
Total dairy exports to Russia were $168.9 million for the year ending June 2021. Of this total, butter represented $147.9 million, comprising 5.5% of New Zealand’s total for this commodity – Russia was New Zealand’s 4th largest butter destination in 2021.
Trade with Russia 2019 – 2021
Exports are mainly made up of dairy whilst imports are mineral fuels and oils – crude oil (well over 90%) and Russia was a moderately important source of crude oil imports (16% of New Zealand’s crude imports in 2020). With Marsden Point oil refinery coming offline in April, Korea and Singapore will in future become the main source of refined fuel. The last significant crude oil shipment from Russia was in January 2021. As at 31 March 2021 New Zealand’s total investment in Russia was worth $14 million, a decline from $48 million as at 31 March 2020. During the same period total Russian investment in New Zealand increased from $29 million to $40 million. The graphic on the right (click on it to expand) shows the origin of imports into New Zealand in 2020. Note that Russia has 0.53% of all imports into NZ.
The largest economic impact on New Zealand of the invasion would therefore be mainly indirect, through higher import fuel and commodity prices, instability of financial markets, and the impact on global economic activity.
Sources:
Potential impacts of the Russian Invasion of Ukraine on the New Zealand economy, February 2022. New Zealand Foreign Affairs.
New Zealand Parliamentary Library – Monthly Economic Review March 2022.
For more on Trade view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.
In my economics classes this week one cannot get away from what is happening in Ukraine and the impact of that geopolitics will have on the global economy. Already I wrote a blog post on Russian interest rates and the collapse of the rouble but what are the challenges ahead for the global economy?
Before the invasion central banks worldwide were tightening monetary policy (interest rates) to reduce the increasing inflation pressure in their economy’s. The price of oil has increased to over US$105 adding to the inflationary problem as policy makers still have to deal with the slow recovery from the COVID pandemic. However the US Federal Reserve (US Central Bank) and the European Central Bank (ECB) have indicated that they intend to continue with their tightening policy of 25 basis points (0.25%) increase in interest rates this month but may have to be less aggressive in their future tightening. Their major concern now is that the war in Ukraine has increased the chances of a period of stagflation – stagnation and inflation at the same time. Therefore it is important that central banks are more sensitive to tightening their monetary policy as adding the Ukrainian crisis (with higher oil and food prices) to the present supply chain issues would increase the chances of stagflation and a significant downturn in the global economy.
Stagflation In economic textbooks there are two main cause of inflation – Demand Pull and Cost Push (see graph below).
The inflation that New Zealand is mainly experiencing is of a cost push nature especially when you look at the recent CPI figure of 5.9%. The major driver of this inflation is:
30.5% rise in the cost of petrol
15.7% rise in the associated cost in buying a new dwelling.
4.1% increase in the food group
What you notice from the graph is that when the AS curve shifts left not only does inflation increase but also output and employment decrease. The last major stagflationary period was during the oil crisis years of 1973 (oil price up 400%) and 1979 (up 200%) – see video below from the Philadelphia Fed.
But when will these cost pressures ease in New Zealand? With a 5.9% inflation rate employees will put significant pressure on employers for wage increases and this is when there is already a very tight labour market (3.2% unemployment).
Final thought 2022 is going to be a very difficult year for the economy with both demand and supply issues: Demand: higher inflation will mean a tightening of interest rates which will reduce spending and increase the debt burden. Supply: higher energy costs, supply chain problems, increase in material costs and availability of parts for industry.
Add to this the war in Ukraine and we are in for a rocky ride. However the possible suffering is necessary if it nullifies the threat on global democracy.
For more on Stagflation view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.
An excellent video from the Wall Street Journal which explains how higher oil prices impact the inflation rate. By pushing up the price of transport this in turn affects the price of goods / services as producers pass on this extra cost to consumers. Although US focused it does go through simple supply and demand theory to explain how the price may fall or rise.
Today Brent Crude Oil prices rose above $105 a barrel (see graph below) for the first time since 2014 after Russia’s attack on Ukraine amplified concerns about supply disruptions. United States is working with other countries including OPEC on a combined release of additional oil from global strategic crude reserves – in theory the supply curve moves to the right to try and reduce prices. Russia is the third-largest oil producer and second-largest oil exporter and low oil stocks and limited spare capacity, will see additional pressure on prices. Furthermore increased demand with a lot of economies coming out their COVID restrictions will put further pressure on prices.
The RBNZ made a forecast that oil prices should head back to around the $80 per barrel mark but that seems to be rather optimistic with the current political climate. What is sure is that higher global oil prices will continue to put pressure on New Zealand’s CPI.
Sign up to elearneconomics for multiple choice test questions (many with coloured diagrams and models) and the reasoned answers on Inflation. Immediate feedback and tracked results allow students to identify areas of strength and weakness vital for student-centred learning and understanding.
ECONFIX 