Why is inflation so high in Europe & what can be done to slow it down?

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Price increases across the eurozone have hit their highest level in 13 years but they should start to ease down in the second half of the year.

The sharp rise in Inflation — which shows an increase in the level of the prices of goods and services that households buy — has grabbed headlines worldwide, sparking concern as January set a new record.

Consumer prices in the eurozone rose by a record 5.1% last month according to the latest European Central Bank (ECB) data, defying expectations of a slowdown.

But what are the reasons behind this and what can be done to slow it down?

What are the causes?

High prices were primarily driven by soaring energy charges and secondly by food.

Eurozone energy prices were in January 28.6% higher than during the same month last year, a record hike, while growth in the cost of unprocessed food accelerated to 5.2%.

The price of services continued to rise 2.4%, while growth in goods prices slowed to 2.3%.

Pandemic-related changes primarily account for these increases.

European economies reopened slowly in 2021 as more and more restrictions were lifted. People started traveling again and going to restaurants, thus buying more, spending some of the money they did not spend during the lockdowns.

But logistics are not moving at the same pace.

Companies are finding it difficult to keep up with rapidly rising demand as they rebuild supply chains that were badly hit by the pandemic.

Challenges, such as a shortage of shipping containers, means transporting goods has become more difficult and more expensive. The longer such difficulties persist, the more likely it is that companies will pass these costs on to their customers in the form of higher prices.

Oil, gas and electricity have also become more expensive around the world.

Energy prices increased as oil-and-gas production lagged behind a return of consumer demand coming out of the pandemic.

According to the ECB, because a large part of companies and people’s costs is related to energy, the price of oil, gas and electricity matters greatly for overall inflation: half of the recent increase in inflation was due to higher energy prices.

How long it could last?

The European Commission said Thursday that inflationary pressures are likely to come down next year.

“After reaching a record rate of 4.6% in the fourth quarter of last year, inflation in the euro area is projected to peak at 4.8% in the first quarter of 2022 and remain above 3% until the third quarter of the year”, the Commission said in a statement.

“As the pressures from supply constraints and high energy prices fade, inflation is expected to decline to 2.1% in the final quarter of the year, before moving below the European Central Bank’s 2% target throughout 2023,” it added.

But uncertainty remains high as the overall European economic outlook is dependent on the geopolitical tensions between Ukraine and Russia but also on the evolution of the pandemic across the world.

Thomas Wieser, an American-Austrian economist who served as the President of the Eurogroup Working Group during the difficult years of the financial crisis, explained to Euronews that it is really hard to predict when inflation will really fall below the ECB target.

“We don’t know. Our situation is better than in the UK or the US, where especially the US sources of inflation are partially different to what we have in the euro area, especially because the fiscal stimulus on top of an already vigorously growing economy was much, much higher there than done in Europe,” he said.

“Secondly, we don’t have a clue when the supply chain problems will start sorting themselves out. There are reasons to hope that in the second half of the year, this will be that much better.

“And thirdly, the rebalancing of demand between goods and services in our economy will only start to pick up once the vast majority of restrictions, including travel restrictions, will be lifted. Again, we can be optimistic for the second half of the year, but nobody knows.”

What can be done to stop rising inflation?

Earlier this month, ECB President Christine Lagarde, said she could not clearly rule out an interest rate hike later in 2022 and said that a March 10 meeting will be crucial in deciding how quickly the central bank would end its long-running bond-buying programme as a pandemic crisis support for the economy.

“If inflation were to continue, I think there are reasons for withdrawing stimulus fairly soon in the course of 2022,” Wieser told Euronews. “Inflation is bad for those who are savers. Inflation is bad for those who have got fixed or fairly stable nominal incomes, and that includes many people on pension benefits plans and therefore a high degree of inflation is always bad.

“And it is not only the central bank whose task it is to rein in or to prevent a hardening of the data around present day inflation levels, it is also part of the enterprise sector looking at price increases, such as part of trade unions in wage negotiations. And it is part of the makeup of European policies from trade policies and others,” Wieser added.

But with poorer households impacted the most, Guntram Wolff, director of the Brussels-based think-tank Bruegel told Euronews that more courageous measures are needed from policymakers.

“What policymakers can do is, of course, give support to these households. I would say the support should not be a cut in the value-added tax on energy, but rather an outright transfer so that they have some more purchasing power,” Wolff said.

“But we still want the price signal to work, so we do want households to, in a sense, try to be conscious of their energy consumption and react to the price signal. But I do think transfers for the poor households are needed.”

While experts are monitoring the situation across Europe and the world, it’s pretty clear that as the pandemic did not hit all countries equally, this is also the case for inflation.

And the debate over how to move forwards in the post-pandemic era will not be easy and has been kicked off with a shadow of geopolitical and financial threats floating around.


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