Miodrag Šajatović: It Is Harder to Contain Inflation Than to Curb the Spread of COVID

The government has presented a package of measures to mitigate the rise in prices due to energy price increases worth 4.8 billion kuna. The package appears to be a well-designed combination of VAT reductions and various forms of subsidies for individuals, businesses, and farmers.

However, this package will have more sustainable long-term effects if the diagnosis is correct that the awakened inflation is merely a consequence of an unfortunate combination of circumstances, disrupted global supply chains, and an unexpected one-time spike in energy prices. But if the diagnosis is wrong, if the unfortunate combination of circumstances has actually only fanned the flames of inflation that has been smoldering for a long time, then the firefighting measures that many countries’ governments, including Croatia’s, are taking will not lead to the desired calming of price growth. In that case, the challenges are very serious.

Middle and younger generations do not have personal experience of inflation (and hyperinflation) that those of us born in the 1950s and 1960s experienced at the twilight of socialism. For a better understanding of what is currently happening, it may help to draw a parallel between inflation and COVID.

Intangible, yet dangerous

The similarities between inflation and COVID begin with the fact that both phenomena are invisible to the eye. They are highly contagious. The infection comes in waves. There are no measures that can stop both epidemics at the borders of a country. Inflation, like COVID, does not intend to destroy the body it has infected, but the victims are nonetheless numerous. In COVID, people suffer physically, while in inflation, the direct victims are companies that end up in bankruptcy, but then also families whose standard of living collapses. Just as COVID is particularly dangerous for immunocompromised individuals, so the inflation virus can be fatal for individuals and companies that are not financially resilient. Those who are highly indebted. Even the commonplace about the vulnerable older population can have a parallel. Due to rising food and utility prices on one side, and the inevitable lag in pension growth on the other, the older retired population is particularly vulnerable.

Inflation, defined as self-sustaining price growth or described as an inflationary spiral, is harder to cure than COVID. For COVID, medical science relatively quickly provided an answer in the form of a vaccine. The effectiveness is not high enough, but it does provide protection against severe consequences. Unfortunately, economic science has not yet devised a vaccine against inflation. Instead of those infected by rising prices suffering a needle prick, economic entities, individuals, families, and companies must undergo a long and painful treatment for most. This consists of reducing real purchasing power (excessive demand with limited supply is a trigger for inflation). The temperature in inflation is lowered by a remedy called rising interest rates. The side effects are very unpleasant for many, the consequences are long-lasting, and recovery is slow.

Perhaps the main argument for the thesis that inflation is a more troublesome virus than the coronavirus is the behavior of the infected. Most affected by the coronavirus accept that they need to be careful not to intentionally infect their surroundings. In the case of inflation, actors, from companies to individuals, try to cure themselves by intentionally infecting someone else. When a company receives a higher gas bill, it will do everything to pass the infection onto its customers for its products or services. When an individual receives higher bills, they will pressure their employer or the state for a higher salary. The company concedes, and thus the higher labor cost is attempted to be passed onto customers. The infection spreads uncontrollably, price indexing becomes common behavior, which is why the inflationary spiral makes ever larger circles.

Hard to Achieve Herd Immunity

We are witnessing that the coronavirus, let us hope that this phase has arrived, weakens over time by itself. The inflation virus shows no desire to weaken. Herd immunity is achieved only when a balance between supply and demand is established after the bankruptcy of many actors.

Additionally, for political leaders in power, the coronavirus is less dangerous than the inflation virus. Nature is to blame for the coronavirus. For the price growth virus, world and local leaders who have not managed the economy well can be blamed with many arguments. Then it is only a few steps to unrest, more serious than protests against COVID certificates.

We should hope that the inflation pandemic will indeed calm down ‘in the second half of the year’. And that packages like this government one will be helpful. However, if the diagnosis is wrong, the remedies aimed at alleviating the consequences of rising prices are very likely to prove to be a stimulus for the inflation pandemic. Instead of reducing effective demand, it is further pumped by government measures. It is like extinguishing a fire with gasoline. 

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