Project Syndicate: A revolution on the supply side is needed to defeat inflation without crushing the global economy

by | Jul 6, 2022 | Stock Market

MILAN, Italy (Project Syndicate)—Central banks’ efforts to contain high and rising inflation are fueling headwinds to growth and are threatening to tip the global economy into recession. But the proximate cause of today’s inflationary pressures is a large, broad-based, and persistent imbalance between supply and demand. Higher interest rates will dampen demand, but supply-side measures must also play a large role in inflation-taming strategies.

Over the past year or so, the rollback of pandemic-containment policies has spurred a simultaneous surge in demand and contraction in supply. While this was to be expected, supply has proved surprisingly inelastic. In labor markets, for example, shortages have become the norm, leading to canceled flights, disrupted supply chains, restaurant closures, and challenges to health-care delivery.Work is seen in a new light These shortages appear to be at least partly the result of a pandemic-driven shift in preferences. Many types of workers are seeking greater flexibility—including hybrid or work-from-home options—or otherwise improved working conditions. Health-care workers, in particular, report feeling burned out by their jobs. If this is true, the inflation picture must include an adjustment in relative labor costs. To bring markets back into balance, wage and income increases will be needed, even for jobs for which there was previously an ample supply of workers.

“ More than 75% of the world’s GDP is produced in countries with aging populations. Old-age dependency ratios are rising, and in some countries, the workforce is shrinking. ”

This transition will generate some inflationary pressure. Yes, nominal prices and wages have limited downward flexibility. But at a time of excess demand, firms generally try to pass on higher costs via price increases—and they often get away with it, at least for a while. Lingering blockages associated with the pandemic, especially in China, which remains committed to its zero-COVID policy, are also fueling inflation. But these blockages will …

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