Inflation Will Rise Longer Due to War, Demand, and Labor Markets – IMF Blog

By Jorge Alvarez and Philip Barrett

The war in Ukraine will accelerate inflation, which we expect will remain high for longer than expected due to rising commodity prices and increased pricing pressure.

As shown in the Chart of the Week, our latest World Economic Outlook now projects faster increases in consumer prices this year for advanced economies as well as emerging and developing economies. These forecasts also have a high degree of uncertainty.

Russia’s invasion of its neighbor is likely to have a prolonged impact on commodities, hitting oil and gas prices more severely this year and food prices well into next year.

Four main factors shape our outlook:

  • The war aggravated the already rising prices of raw materials. Energy and food helped boost inflation last year, with oil and gas supplies tight after years of subdued investment and geopolitical uncertainty. This has been one of the main drivers of inflation in Europe and, to a lesser extent, in the United States. Rising food prices also played a major role in most emerging markets and developing economies, as extreme weather reduced harvests and rising oil and gas prices pushed up the costs of fertilizer.
  • Demand surged last year amid political support, while supply bottlenecks widened due to factory closures, port restrictions, shipping congestion, container shortages and worker absences. Inflation has risen accordingly, especially where recoveries have been strongest. Demand is expected to weaken this year as political support is withdrawn and supply bottlenecks ease, but recurring blockages from China, war in Ukraine and sanctions on Russia will likely prolong disruptions in some sectors until next year.
  • Demand is also rebalancing from goods to services. Spending shifted to goods as pandemic restrictions disrupted in-person activities, with supply bottlenecks helping to drive up prices of goods. Although services inflation started accelerating last year, pre-crisis spending patterns have not fully returned and goods inflation remains predominant in most countries. Demand for services will increase further as the pandemic subsides, and headline inflation is expected to return to pre-coronavirus levels.
  • Labor supply remains constrained after significant tightening in some advanced economies such as the US and UK. Labor shortages, mainly in contact-intensive industries, are driving up wages, although inflation has eroded wage gains. Meanwhile, the pandemic has reduced labor force participation in advanced economies. These changes seem linked to early retirements and the fact that workers are unwilling or unable to return as infections continue. Some workers work fewer hours. We assume labor supply will gradually improve this year as the health crisis abates, but the effects will be muted and unlikely to significantly ease upward pressure on wages .

Under these conditions, we expect the already high inflation to persist for longer. Our projections predict that the pace in advanced economies will hit a 38-year high of 5.7%, while price increases in emerging markets and developing economies will accelerate to 8.7%, the fastest clip rapid since the global financial crisis of 2008. These rates would then cool next year to 2.5% and 6.5%, respectively.

It is important to note that the price spike will have the greatest effects on vulnerable populations, especially in low-income countries. High headline inflation will also complicate trade-offs for central banks between containing price pressures and safeguarding growth.

While our baseline forecast is that inflation will eventually come down, inflation could turn out to be higher for several reasons. Worsening imbalances between supply and demand, particularly as a result of the war, and further increases in commodity prices could keep the pace of inflation high. Moreover, both war and new pandemic outbreaks could prolong supply disruptions, further increasing the costs of intermediate inputs. Amid tight labor markets, nominal wage growth could also pick up to catch up with consumer price inflation as workers seek higher wages to preserve purchasing power. This would further intensify and widen inflationary pressures, with the risk of unanchoring inflation expectations.

About Andrew Estofan

Check Also

UK employers urged to give workers early pay rise

UK employers who pay the voluntary ‘living wage’ have been asked to give an early …