December 17, 2021
Inflationary Boom in US and Pakistan
After the deep recession triggered by COVID-19 in the spring of 2020, the world economy has recovered dramatically. Some countries have done better than others, but there has been a marked upswing in economic activity around the world, and this has led to inflation reaching levels not seen for decades in developed countries, and rising sharply in many developing countries.
For the US, the massive pandemic relief bills that totaled about 5 trillion dollars since April 2020 have done their job. Poverty actually declined to record lows, while the GDP is actually larger now than it was in February of 2020. Most of the jobs lost in the pandemic have been regained, though employment is still about 4 million less than 20 months ago. Some people have retired, while others are afraid to venture back or have childcare issues keeping them out of the workforce. But help wanted signs are everywhere, and employers are scrambling for workers. Pay rates for those at the bottom have been surging upward, with some Starbucks in New York offering 23 dollars/hour to serve coffee.
As Americans spend like crazy, and the rest of the world is doing the same, shortages have popped up. Oil prices surged to over 80 dollars/barrel from a low of 20 dollars in 2020, while coal, lumber, coffee, and other commodities also surged. Food prices around the world have jumped sharply, for both grains and meat. In the US, where inflation averaged less than 2% per year for the last decade, the rate jumped to over 6% year over year in November. These kinds of numbers are politically toxic, and Americans over the age of 60 still remember the painful inflation of the 1970’s. The fear some have is that we are heading back into a period of sustained inflation that may go on for years.
This however is highly unlikely. Inflation has likely peaked in the last couple of months. Oil prices have already declined to 70 dollars/barrel, and other commodities are coming down. Snarled supply chains are slowly coming untangled, which will reduce price pressures from shortages. Much of the recent inflation is confined to specific sectors that are linked to the pandemic, like rental cars and air travel. Used and new cars also were badly hit with price hikes due to auto companies savagely cutting production in the last year over fears of how long COVID would hold down spending.
Meanwhile, American policymakers are acting to dampen demand and bring inflation down. The biggest factor is the withdrawal of the massive deficit spending doled out in the last two years. Budget deficits will decline rapidly from 3 trillion dollars in the last year to 1 trillion in the current. This is massive fiscal tightening. On top of that, we can expect the Federal Reserve to tighten monetary policy. The aggressive bond buying (quantitative easing, or more bluntly, printing money) of the Fed will taper off in the next couple of months after which the Fed will start raising interest rates. If all goes well, by next November the economy will have grown substantially, added several million more jobs, and experienced a decline in inflation to less than 4%, perhaps even less than 3%. Such an outcome will be most welcome by the Biden White House, whose approval ratings have been lackluster recently, and will prove costly in the 2022 midterm elections if they don’t pick up.
Pakistan too is experiencing an inflationary boom. Farm incomes are doing well as there have been bumper crops of wheat, cotton, rice, and corn. Sales of motorcycles have surged to an all-time high in November. The corporate sector is reporting record profits. A domestic smartphone assembly industry is growing rapidly. Tax collections are coming in much higher than expected, a sure sign that economic activity is robust. Exports are surging, and textile exports reached over 6 billion dollars in the July to October period, compared to 4.4 billion dollars in 2018. Auto sales are also strong, while electricity production is up 10% over last year.
The economy is surging in Pakistan, but prices are also going up rapidly, with inflation over 10% in November. Inflation in Pakistan is also driven by the rise in global commodity prices, and oil prices are particularly important to Pakistan’s economic performance as oil in entirely imported. With inflation running hot, the rupee is losing value relative to the dollar, and hence the exchange rate has dropped to 178 rupees to the dollar. This is not by itself a bad thing. A weaker rupee helps make Pakistan’s exporters more competitive on price compared to other countries, and also makes imports more expensive in rupee terms, which should help dampen demand for imports. Pakistan has a massive trade deficit, importing almost twice of what it exports. It can only pay for all those imports due to the 30 billion dollars in remittances overseas Pakistanis send home. Without those remittances, Pakistan would have to import tens of billions of dollars less every year.
In response to the economy starting to overheat, and the import bill rising much faster than exports, the State Bank of Pakistan has responded with rapid increase in interest rates. Monetary policy has tightened with rates now at 9.75%, which is higher than the core inflation rate, and makes policy mildly restrictive. The SBP expects inflation to slowly cool off to less than 7% by 2023. Growth should likely stay robust at over 5%. Because the GDP base has not been recalculated since 2006, the GDP growth numbers are likely a sharp underestimate. If the official number is 5% the actual growth rate is probably closer to 7%, which would be about as fast as Pakistan can grow.
The global surge in inflation is likely a temporary pandemic phenomenon, and should subside in the next 12 months. The key for policymakers in the West and in developing countries is to keep growth robust and not to overreact to the current headlines. The one danger still lurking is if COVID were to make a dramatic resurgence due to mutant variants that get by the current vaccines. So far, it looks like the Omicron variant is able to get by standard vaccines, but is blocked if people get a booster. More importantly, while it can still infect many who are vaccinated, it does not seem to cause severe or critical illness in vaccinated patients.
In addition, new vaccines designed specifically for Omicron should be available from Pfizer and Moderna in the next 2-3 months. Finally, Pfizer has developed an extremely effective drug that treats COVID by blocking viral replication. In clinical trials it cut severe disease and death by 90%. This drug has the potential to truly end the pandemic’s grip on the world, if enough of it can be supplied to those who need it.
