What will happen to inflation in 2022?

By Ryan Avent: Trade and international economics editor, The Economist, Washington, DC

IN THE YEARS immediately before the pandemic, worrying about inflation seemed as passé as bell-bottomed trousers and leaded petrol. But as the global economy clawed its way back from the deep recession induced by covid-19, the old scourge reappeared. Inflation rose above 5% in America and 3% in Britain, and roared much higher in many emerging markets. Some economists warned of the imminent return of the chronically high inflation of the 1970s. Developments in 2022 will put such fears to rest—but not before making central bankers sweat a bit.

From the 1980s, inflation rates across much of the world began a slow downward march that persisted into 2020. The drop was in part a reflection of central bankers’ success in learning to keep price pressures under control, but their work was made easier by a number of structural trends. Globalisation reduced production costs and crimped workers’ bargaining power, suppressing wage growth. And as rich-world populations aged, they saved more, which meant consumption did not jump as much in response to income growth as it had in the past. In the aftermath of the global financial crisis, inflation persistently undershot central banks’ inflation targets, encouraging some, such as America’s Federal Reserve, to give themselves more freedom to push inflation up: a striking reversal for institutions with reflexively hawkish instincts.

Then covid-19 struck. To shore up financial markets, central banks ploughed huge amounts of money into the financial system. Governments borrowed on a scale not seen since the second world war, to bolster the incomes of those unable to work. America’s government budget deficit exceeded 12% of GDP in both 2020 and 2021.

This stimulus kept demand from tumbling, but supply was a different story. Covid-19 interrupted production of all sorts of goods and services. Droughts and heatwaves contributed to disappointing harvests for crops such as coffee and wheat. And problems in global shipping led to unprecedented freight backlogs. Inadequate fuel supplies caused prices of coal, gas and oil to rocket upward as winter approached, kindling memories of the energy shocks of the 1970s.

In such pressures, some economists—such as Larry Summers of Harvard University—see the first signs of a new era of troublingly high inflation. Firms’ struggles to fill job openings could indicate that the era of weak labour power is drawing to a close. Central banks now place a higher priority on achieving low unemployment than they once did, and so might be too complacent about inflation risks. Inflation can also feed on itself. As people get used to larger and more frequent price increases, firms may find that putting up prices is less bad for business than it used to be. Inflation expectations, as economists say, could become “de-anchored”. Surging energy costs could squeeze growth and productivity.

Though inflation in 2022 will continue to overshoot central-bank targets, it will decelerate from 2021 and eventually fade as a macroeconomic concern. Energy prices should plateau and fall in the spring, thanks to the easing of energy demand, increased fuel production and perhaps also a slowing Chinese economy. Shipping problems may take longer to unwind. But stimulus taps are being turned off around the world, and high energy bills will squeeze household budgets. As vaccination rates rise, more workers are likely to return to the labour force, and spending may shift back toward services, helping alleviate goods shortages.

Most importantly, many of the structural factors that dragged inflation down in the years before the pandemic remain in place. Powerful trade unions are not staging a comeback, populations continue to age and, despite stresses on global supply chains, there are few signs of a broad reversal in globalisation. Neither have central bankers forgotten how to rein in inflation. Indeed, in 2022, interest rates will rise across much of the world. Inflation is back—but not for long.

Ryan Avent: Trade and international economics editor, The Economist, Washington, DC■

This article appeared in the Finance section of the print edition of The World Ahead 2022 under the headline “Back, but not for good”