Energy prices skyrocketed and the cost of groceries went up significantly: life suddenly became more expensive in many places starting in early 2021. The annual rate of change in the consumer price index (CPI), an established measure of price developments, had risen to 8.6 % for the group of advanced economies by October 2022. Two years earlier, it had stood at just 0.7 %. Inflation even hit double-digit figures in the euro area. It increased significantly in emerging market economies, too. 

In many countries, inflation was initially driven by high demand for goods. Extensive monetary and fiscal policy support measures played an important role here. As consumption of contact-intensive services, such as visits to restaurants or hairdressers, was restricted during the coronavirus pandemic, households increasingly purchased goods. As a result of this shift in demand, global industrial production rose considerably and global trade experienced a rapid and strong recovery, the article explains. Many enterprises were then unable to quickly adjust their production to the high level of demand. In addition, supply chain disruptions were triggered, for example, by closures of plants and ports, which led to a shortage of key industrial intermediate inputs. In this environment of sharply rising production costs and high demand, enterprises in the manufacturing sector, in particular, were also able to significantly increase their mark-ups, the authors wrote. 

Following the start of Russia’s war of aggression against Ukraine, numerous commodity prices, especially for energy and food, then surged again. Furthermore, the end of the pandemic saw many people releasing their pent-up demand for services, which pushed up their prices. Lastly, wage growth also picked up in view of the labour markets being very tight. This further fuelled inflation.  

Central banks respond to inflation high

All over the world, central banks responded to the high rates of inflation by substantially tightening their monetary policy, in some cases after initial hesitation.

In the United States, the Federal Reserve System raised its monetary policy interest rates by 5.25 percentage points over a period of one-and-a-half years. In the euro area, the deposit facility rate rose from − 0.5 % in June 2022 to 4 % in September 2023. Since then, global inflation rates have fallen considerably. Experts also refer to this process of falling inflation rates as “disinflation”. Compared with past experiences, [...] successes in combating inflation were achieved relatively quickly, the economists said of this. 

Economic losses are moderate

The remarkably rapid tightening of monetary policy [...] would have led one to expect a considerable slowdown in the real economy, the economists continued. However, overall economic losses have actually been moderate so far. While gross domestic product in the euro area has remained markedly below its trend since the end of 2022, the authors reported that aggregate output losses were no greater than in previous episodes of disinflation. According to the article, This is already remarkable given the above average decline in inflation. This is because, in the past, comparatively large successes in combating inflation have often been accompanied by recessions. 

As per the economists, the relatively “painless” disinflation process thus far can be explained, first, by factors that had been driving inflation upwards in the first place. Since then, various disruptions to production processes that were caused by the pandemic have been resolved. Second, falling commodity prices contributed to disinflation. At the same time, they boosted economic activity. However, severe economic slumps have largely been avoided for other reasons, too. For example, savings and orders that were accumulated during the pandemic boosted aggregate demand. In addition, fiscal policy was expansionary in many places. Due to these developments, but also due to their experience gained during the pandemic, enterprises continued to hire workers up to the end of the period under review.

Carefully weigh up further interest rate cuts

So what comes next for inflation and the economy? After all, many central banks’ inflation targets still have yet to be fully achieved. The Eurosystem, for example, is aiming for inflation of 2 % over the medium term. In June 2024, however, the inflation rate in the euro area was still 2.5 %. “Since the start of 2024, there have been at most minor successes in the fight against inflation in some places, the article explains. According to the authors, a number of factors supporting economic activity are making it more difficult to achieve inflation targets. Labour markets are still very tight, wage growth remains brisk and inflation is still strong, especially in the services sector. At the same time, relief provided by the supply side appears to have largely petered out. Geopolitical conflicts could even push inflation back up again. Potential further interest rate cuts should therefore be carefully considered in light of incoming data,” the economists wrote, advising a data-dependent approach in line with the ECB Governing Council’s communication.