Prices: Globalization Has Tamed Inflation, But Has Not ‘Killed’ It

Although many economic experts, somewhat like doctors, like to think that this side no longer hides secrets for them, at least when it comes to diagnosis, the recent mysterious absence of high inflation in developed countries has caused many to scratch their heads because this time it is not easy to isolate a unique and simple cause. More precisely, it seems that there is no single reason for the strange shyness of inflation, but rather the complexity of the global economy offers several different, parallel reasons that together dismantle the long-established economic link between a large amount of money and the general rise in prices.

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For the last twenty years, inflation has stubbornly refused to appear despite the relentless work of printing presses, or the modern equivalent of that, loose monetary policy. If one were to try to find a common denominator for this phenomenon that economists explain differently, it would probably be globalization. It seems to have ‘killed’ inflation, or at least temporarily tamed it, although it should never be completely written off, as experience from the 1970s teaches us when, according to popular interpretation, Keynesian policy ran aground on stagflation (stagnation combined with inflation).

Confusion Among Economists

The rapid development of the global economy paired with an explosion of technological possibilities has created conditions in which the space for greater price growth is limited, which does not mean that it does not exist. Globalized supply and demand mean great efficiency in which the cheapest suppliers are easily found, keeping the prices of a wide range of products continuously low.

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– Persistently low inflation is the result of deeper economic integration over the past thirty years and corresponding technological advancement, believes Kristijan Kotarski from the Faculty of Political Science in Zagreb, as do most economists.

Marijana Ivanov from the Zagreb Faculty of Economics claims that ‘global competition, hyperproduction, rising productivity, and increasing imports of goods from low-cost labor countries (low total production costs) are certainly reasons for low inflation rates in the last two decades.’ Even more specific is Vedrana Pribičević from the Zagreb School of Economics and Management, who acknowledges the confusion among economists but also offers possible reasons.

Suspicious Measurement of Inflation

There are several potential causes. One of them is the proliferation of online shopping (such as Amazon, ed.) which reduces individuals’ market search costs and diminishes companies’ market power, making it very easy to find a substitute if a company tries to raise its product prices. Companies like Amazon can offer lower prices because they have optimized supply chains. The best example of this is IKEA. For instance, the design and materials of the Poäng chair have not changed for decades, and thirty years ago it cost more than $300, while today its price is $79.

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Another possible cause, according to Pribičević, is the aging population (older individuals spend less, thus reducing inflationary pressure through lower aggregate demand), and the measurement method should not be overlooked either. Recent research suggests that the CPI (consumer price index) is likely biased because some more direct forms of measurement show higher inflation rates than the CPI.

– We measure inflation with the consumer price index, which does not include the prices of financial and real assets, raising the question of whether focusing on this measure of inflation takes into account the overall effects of monetary-inflationary action, confirms Ivanov’s measurement shortcomings.

All this does not mean that higher inflation as a phenomenon has been eradicated and that this situation should be considered permanent. Moreover, a persistently low rate on the brink of deflation is an undesirable other extreme that should certainly be avoided. There are many potential causes for significant price increases in the world, and it is quite likely that they will emerge at some point. Thus, even under current conditions, inflation is possible due to rising oil prices, still a key energy source affecting all other prices, or basic agricultural products (heavily dependent on unpredictable weather conditions), warns Ivanov.

All interlocutors agree that despite the long absence of inflation, this phenomenon should not be written off. According to Kotarski, the return of a large number of people to the labor force could create inflationary pressures in the future because economic science has established a strong link between the employment rate and inflation growth.

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It should also be kept in mind the extremely negative development of events in which the trade measures of U.S. President Donald Trump threaten to push the world into a protectionist spiral. If that happens, ‘then global value chains will become increasingly fragmented, which will raise production costs and increase inflation,’ warns Kotarski. Unlike the volatile nature of oil prices, agricultural products could prove to be a lasting cause of inflation due to climate change, which can significantly affect the price growth of these products, and thus the overall price level, notes Ivanov, adding that inflation can also arise due to demand.

Expansionary Monetary Policy

– Demand inflation can be caused by excessive growth of credit and money supply, but this may not be the case if credit and money are mainly used for investments in real estate, stocks, bitcoin, or other assets. In developed countries, credit continues to grow relatively slowly, which is also true for Croatia. Although the monetary policy of many central banks remains expansionary, the scope of their action remains at high bank liquidity and low interest rates (which still encourage sufficient investment growth), and banks have large amounts of liquidity surpluses that they have no one to lend to because demand remains weak, which is why primary money does not convert into money in circulation, and only such money can have an inflationary effect on demand growth, explains Ivanov.

Efficiency Curbs Price Growth

An interesting global perspective is also offered by Ivanov. In the context of inflation, he highlights significant differences between developed economies and emerging markets (EMDE).

– The unaddressed problem of poverty in EMDE and low-income countries thus has a dual effect on maintaining low inflation: on one hand, it is the supply of cheap labor and, accordingly, cheap products and services that are exported to the global market, and on the other hand, the problem is that the consumption possibilities of the dominant part of the world’s population remain limited. With the pronounced problem of income and wealth concentration among a very narrow circle of people, the space for stronger growth of global demand, and thus the demand-side causes of inflation development, is limited, while productivity growth (lower labor costs and technological advancement), ‘fiscal consolidation’ policies, i.e., austerity measures, structural reforms, and other measures reduce cost inflation, concludes Ivanov.

Inflation has indeed been unusually low for a long time, regardless of measurement differences, but claiming that it has been eliminated as a phenomenon would be a great exaggeration and certainly incorrect. A high degree of globalization may have created the most efficient global market ever, which manages to keep inflation at a sufficient distance, but many factors can disrupt this. Therefore, the return of inflation is quite likely.