November 27, 2021

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DNB: High inflation is temporary, but it may become permanent

DNB: High inflation is temporary, but it may become permanent

Home prices are on the rise, groceries are getting more expensive and every refueling hurts the wallet a little more. Are high inflation temporary or will these price increases continue in the coming years? Many economists have been pondering this question since inflation hit the ceiling late last year.

The European Central Bank (ECB) has always reassured that inflation will return to normal soon, as higher price increases are a temporary consequence of the economy’s recovery from Corona. But a year and a half after the start of the Corona crisis, according to CBS, inflation has reached 3.4 percent, the highest level since 2002.

However, the current high inflation may be temporary, concludes De Nederlandsche Bank (DNB) in a new analysis. According to DNB, high inflation can be explained by a number of temporary factors, some of which will disappear in the coming months. For example, the so-called base effect: Prices were relatively low last year and the correction alone is contributing to inflation.

Another part of the factors is also temporary, but it seems to last longer than originally thought. This applies to Energy price hikeAnd Delivery problems and the increasing of demands on products because people put off buying during the pandemic.

“For eight years, we’ve held a kind of useless rain dance of more inflation, and now the corona shock is suddenly causing more inflation,” says DNB President Klaas Knot. in a news hour. “The interesting question is: Factors that lead to higher inflation temporarily, how temporary are they? If they continue for longer than we think, we as central bankers will have to respond.”

spiral wages

The DNB writes that it is possible for businesses and households to adjust their behavior with high inflation. If this happens, the so-called Effects of the second round It can keep inflation high for a longer period of time.

For example, unions can demand higher wages, and then employers pass those higher wages on in rates. These higher prices, in turn, can lead workers to want wages to rise again, leading to a wage and price spiral that leads to higher inflation.

The DNB does not yet see any signs of such a wage-price spiral, but it warns against it. For example, it is possible that companies that are still reluctant to raise wages due to uncertainty about the Corona pandemic will do so later, the DNB wrote..

With the prolonged high inflation, people no longer dare to take financial risks.

Matejs Baumann, Economist

Remarkably, the DNB chose to include this warning in its analysis, says economist Mathijs Bowman. “There is also a strategic significance behind this. DNB Chairman Klaas Knot has been opposing the stimulus measures that the European Central Bank has taken for years to keep inflation in the Eurozone. If high inflation is temporarily lower than originally thought, these measures may actually be partly unnecessary. “.

If inflation has already reached a long-run high level through the wage-price spiral, a situation arises in which money quickly loses its value. “And then you get a lot of unwanted redistribution,” Bowman says. “For example, some people are in a position where they can easily demand a higher wage, while others cannot. But the most important thing is that people no longer dare to take financial risks, because of the uncertainty about the value of their money.”

Positive effect

But if inflation really gets out of control, the ECB will always take action, Bowman says. This can be done, for example, by raising interest rates. “Plus, the longer you wait, the more painful these procedures will eventually be.”

By the way, a short period of high inflation can have a positive effect on the economy, writes the DNB. Since inflation has long been below 2%, a temporary high rate of inflation could “cement” inflation expectations among citizens and businesses around the ECB’s target. “Often expectations are the main driving force behind the level of inflation,” Bowman says.