Global Inflation, Quantitative Easing and the Potential for a 2022 Recession

Anthony Budiawan
Anthony Budiawan. Managing Director of Political Economy and Policy Studies (PEPS)

IO – Many countries are facing swelling inflation, posing a new threat to a world economy that has not fully recovered from the COVID-19 pandemic recession. The United States recorded 6.2% annual inflation in October 2021, compared to October 2020 (Year on Year, YoY), the highest rate in the last 30 years.

Inflation is on a rise for the prices of a basket of goods reflected in the Consumer Price Index (CPI). In addition to consumer goods inflation, another is inflation of production costs, named the Producer Price Index (PPI), an increase of input costs or prices at the producer level.

Any increase in production costs will erode people’s purchasing power and burden the economy. Producers in general will pass on higher input costs to buyers; thus, prices of goods will surge. If the market cannot absorb a production cost increase, then producers will have to grin and bear it. Company profits will inevitably fall. In a frail economic condition, many companies will suffer losses as their costs increase uncontrollably.

The producer price inflation in the States for October 2021 was also quite steep at 8.6% (YoY). This figure is closest to the high inflation recorded in early 2008, when the economic bubble popped, resulting in the 2007-2008 global financial crisis.

Increased input costs do not exclusively afflict the United States but are evident in all developed countries, including China, as the world’s largest producer and exporter, where the phenomenon was even more significant than in the United States. Production cost inflation in October 2021 was recorded at 13.5%, the highest since mid-1995, 26 years ago.

Soaring inflation raises two big questions. First, how could there be such acute production cost inflation amid world economic growth that has not fully recovered? Second, what are the consequences of a steep increase in inflation on the world economy and on Indonesia in particular?

The COVID-19 pandemic has knocked the world economy into recession since early 2020. To combat this effect, almost every country in the world has implemented very aggressive fiscal and monetary stimuli, starting in March 2020. The world’s leading central banks, such as the Fed (Federal Reserve), the BOE (Bank of England), and the ECB (European Central Bank) have all cut their benchmark interest rates to almost zero percent, within a few days. What’s more, those central banks also aggressively applied quantitative easing, forcibly injecting liquidity by buying government securities held by the financial sector.

The impact of this monetary stimulus was extraordinary. Commodity prices soared in the middle of a recession. The average monthly price of WTI crude oil rose 185% in nine months, from April to December 2020. Prices of coal, palm oil and rubber rose 42%, 67% and 75%, respectively. Meanwhile, world demand for these commodities remained stagnant during the recession.

Commodity prices continued to skyrocket in 2021. The average monthly world crude oil price rose 333% in September 2021 compared to April 2020. Coal prices rose 217%, and palm oil prices rose 94% in the same period. This high rise in commodity prices increases production costs: the producer price index climbs.

An explanation of the above clearly illustrates that the monetary stimulus policy and quantitative easing, as an effort to overcome the 2020 pandemic economic recession, have actually caused swelling commodity prices and high inflation. An increase in commodity prices occurred, even though the economy was weak and has not returned to its normally robust state, and the unemployment rate is still relatively high. This condition, where inflation is high and the unemployment rate is also high, is called stagflation, and it poses a dire threat to the economy and welfare of people everywhere.

In general, the unemployment rate and inflation have a negative correlation. This means that if the unemployment rate is high and purchasing power is weak, then inflation is low, or deflation may even occur, such as at the beginning of the 2020 recession. In contrast, if the unemployment rate is low and purchasing power is relatively strong, then inflation tends to increase.

This general condition does not apply if inflation is caused by an increase in production costs, or cost-push inflation, as is currently happening through an increase in commodity prices for crude oil, coal, along with other food and mineral commodities, caused by excessive monetary stimulus and quantitative easing.

If this condition persists, the stagflation of the 1970s could be reignited. The crude oil price in the 1970s rose from around US$3 per barrel in late 1972 to US$35 per barrel in 1981, skyrocketing production costs during a relatively high unemployment rate.

The current economic condition could lead to stagflation if massive quantitative easing continues onward, causing commodity prices to go through the roof and setting off higher production costs and consumer prices.

It should be noted that commodity prices are currently far below their peak prices in mid-2008 or early 2011. It means that the rising commodity prices are a real threat.

To cope with increasing commodity prices and inflation, the world’s central banks are advised to take corrective policies by reducing the quantitative easing stimulus and slowly raising the benchmark interest rate.

The rising interest rates and monetary tightening, consequently, will halter economic growth that has yet to fully recover. The recently detected Omicron variant only added complexity to economic recovery, potentially bringing the world economy back into recession. Social restrictions on local and international mobility are again tightened up.

The world economic environment these days is not favorable for Indonesia, a nation that has already been in a difficult position.

If the quantitative easing policy continues, inflation will pop, and Indonesia’s economy will stagnate and tend to slide into recession. Inflation will spike. Because of rising domestic fuel prices and the skyrocketing price of imported raw materials, production costs and the price of finished goods will consequently increase.

At the moment, the price of certain basic food items has shown some increment. The price of cooking oil has increased by more than 60% – to 100% or even more – and has already exceeded the Maximum Retail Price (MRP). Strange but true. The cooking oil businesses may violate the MRP, but other commodities, such as rice or sugar, should not even think of breaking the MRP policy. If they do, they may find themselves in an unfortunate predicament, even arrested and imprisoned. This seems to be a clear example where policies for the oligarchs can be shaped according to their needs, despite being unlawful. As for policies for farmers, regulations must be enforced. Is this what is known as “Laws grind the poor, and rich men rule the law?”

On the contrary, if the monetary correction policy is implemented: quantitative easing is halted and the central bank’s benchmark interest rate rises, the Indonesian economy will slow down. The country will possibly slump into a recession. First, this correction policy will reduce the price of Indonesia’s mainstay export commodities, widen the current account deficit, and depress the Rupiah exchange rate. To stem the flow of dollars abroad (capital outflow), Bank Indonesia will raise the benchmark rate, in response to other central banks’ interest rate hikes. All this will have the effect of depressing the economy.

Indonesia’s string of problems becomes longer with the increasing VAT rates and the expansion of taxable goods targeting basic foodstuffs, health services, and certain educational services, a policy to be implemented in April of next year. The VAT increase will weigh people’s purchasing power and trigger inflation. On the other hand, commodity price pressures will reduce state revenues from both taxes and non-taxes, squeezing fiscal stimulus.

In other words, the economic future of Indonesia looks pretty bleak. Daunting. Recession is lurking.