Rise in inflation should not last

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Paul Sweeney13/01/2022

A year ago here on Progressive Economy, I asked if inflation was about to take off. Regrettably it has. The Irish Consumer Price Index (CPI) rose to a surprisingly high 5.3% by November last. The question on everyone’s mind is whether it will fall again soon after the covid-induced supply chain issues are resolved or will it continue at over 5% a year?

Recent Trends

Irish Consumer Prices had actually fallen by 1.5% in the year to October 2020, and price levels at end of 2020 were the same as twelve years earlier in 2008. Thus we enjoyed more than a decade of price moderation. This was in stark contrast to soaring inflation of sometimes over 20% in the 1970s and 1980s.

The main reasons for the 5.3% November 2021 increase was energy price rises, driven by the international market because of increased demand as economies pick up along with some gas shortages.  Energy prices rose 26% on a year earlier and quickly pass through to our utility bills and car fill. Shortages of goods in the global supply chain due to Covid also generated price increases. Eurozone inflation rose by 5% in December and this measure (no mortgage interest) showed a rise of an higher 5.7% for Ireland. Will this boost in inflation be temporary?

The Green Transition

The transition to a truly green economy will impose challenges including temporary costs including some price rises. Greenflation is a term describing inflation which is due to the shift to the green economy.

The impact of the high demand for green metals such as lithium, cobalt, copper and aluminium for e-cars, phones etc, (in reality, no metal is truly green) is pushing up prices for these raw materials, leading to the highest annual increases for green commodity prices for nearly fifty years.

Further, green politics is pushing up energy prices because as we shift to green, there have been growing energy shortages with the run-down of fossil fuel power plants, without sufficient reliable wind or solar power to replace them.

Thirdly, green politics has reduced raw material supplies in many areas because investment in mines and in oil and gas fields has dropped sharply in the past five years, with lower output pushing up prices.

So green metal prices will remain high but as they only make up a small proportion of the costs of say an e-car, this problem should be manageable. Until we are successful in shifting investment to the green economy, prices for energy could remain high. When the shift to green energy is completed, it should mean that new green energy prices will fall in time, as we cross over this temporary bridge.

However, the transition to green energy production will not be easy and will entail the use of gas for electricity generation for a decade or more, contentious though this is. We simply do not have enough green power as yet. We have run out of our own Irish gas, but the price of gas was internationally set.

The European Union has decided that gas is to be part of the green transition. However the recent rise in gas prices contributed to inflation. One-third of European gas comes from Russia which has been carefully maintaining high prices by restricting supplies. It has been estimated that the 20% increase in supply would reduce prices by 50%. Thus can be seen by Russia does not want to see a big fall in gas prices. But Russia an autocracy, is over-dependent on oil and gas, and this is like to remain so for years because the rule of law and innovation are weak. Thus it cannot afford to cut off supplies or push up prices for long. The shift to green ie wind and solar production will reduce or eventually eliminate EU's dependency on Russian gas and on gas and oil in general.

Another factor which will add further to inflation is the record levels of savings in all economies which will be unleased as soon as the pandemic looks like it is easing. This will lead to  a big a consumer boom, also boosting consumer prices. A  high proportion of these savings may go into capital spending, such as housing and investments, but the main impact will be on consumer prices. Again it should not be long lasting.

The Immediate Irish Inflation Outlook.

The Irish Central Bank expects that this year inflation will average 2.9% with some easing during the year. This is up on this year's average CPI rise of 2.1% but it will then fall to 1.9% in 2023. It forecasts that while "the upward pressure on prices from higher energy costs is forecast to ease next year, there is a risk that product and labour supply constraints persist as demand remains relatively strong." In short, unions may seek to compensate for inflation with higher wage demands and with labour supply constraints, they are likely to be successful. This could push up prices. The ESRI forecast is for prices to rise next year to a higher level than the bank's at 4%.

The EU Commission believed in Autumn 2021 that there would be a strong rise in prices in Europe in 2021 and moderating annual rates in the next two years. "Currently, bottlenecks combined with strong base effects and demand pressures are pushing prices up. Still, the narrative that these upward price pressures are strong but only transitory remains intact." It pointed out that this analysis is broadly shared in the latest projections by the IMF, ECB, and OECD. Phillip Lane, chief economist of the ECB believes this is "a pandemic cycle of inflation" and will ease. If these forecasts are correct that this bout of inflation will not last long, then all can relax on this issue.

Conclusion

Those who forecast inflation would fall fast were wrong, but it was seen that most institutions  still hold that it will not remain high for long. The transition to the green economy does present challenges, including on prices, but they are surmountable. The strong case for investment in the green transition is further strengthened by the need to move away from dependence on Russian gas and all fossils fuels.

The Covid pandemic has lasted much longer than anyone had expected. Yet most economies and Ireland's performed far better than had been expected during the pandemic. Recent high Irish tax returns demonstrate this, showing a resilience that augers well for the future.

Key words: Inflation, Covid, Green Economy

Posted in: Banking and financeFiscal policyInvestmentTaxation

Paul Sweeney     @paulsweeneyman

paul-sweeney

Paul Sweeney is former Chief Economist of the Irish Congress of Trade Unions. He was a President of the Statistical and Social Enquiry Society of Ireland, former member of the Economic Committee of the ETUC, a member of the National Competitiveness Council of Ireland, the National Statistics Board, the ESB, TUAC, (advisor to OECD) and several other bodies. He has written three books on the Irish economy and two on public enterprise, including The Celtic Tiger; Ireland’s Economic Miracle Explained and Selling Out: Privatisation in Ireland, chapters in other books and many articles on economics.


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