2022 seem to have a positive outlook, reflecting favorable economic conditions and a promising recovery. Businesses have shown a great deal of adaptability, government enacted progressive policies, and the investment industry bounced back stronger and more resilient. However, looming challenges could derail the recovery: high, persistent inflation is likely to push central banks to tighten monetary policy, complicating efforts for long-term growth. At the same time, COVID-19 has brought to the fore the need for businesses to re-think their supply chain management to cope with uncertainty.
Supply Chain Disruptions
Innovation and adaptation are key:although business’ innovation and government stimulus has meant financial stability, less volatility, and no major crashes, the pace of recovery has not been uniform across all industries and for all businesses. In the US for instance, there has been a K shaped recovery in late 2020, where some industries showed a quick recovery while others continued to struggle. This is due to how well equipped and resilient businesses are in the face of crises. Firms have different business models and behave differently when it comes to risk and uncertainty.
Economics teaches us that shortages increase prices. Businesses supply products and consumers demand them. For a particular product, the balance between supply and demand is its price. If supply exceeds demand, the price falls until demand picks up again. A rising demand reflects consumers’ decision to buy, driven mostly by such factors as better economic outlook and the expectations of higher income. Alternatively, if demand exceeds supply, the price of the product increases until demand for it declines or its supply by producers increases. In a worst-case scenario, when supply declines and demand rises at the same time, the price of the product climbs sharply, resulting in inflation.
This is precisely what happened; supply chain bottlenecks have disrupted the supply of a whole range of products, including food and beverages and consumer electronics. At the same time, government stimulus provided the incentive for consumers to continue shopping, thus sustaining demand. In the early days of the pandemic, hardly any toilet paper or paper towels could be found on the shelves of grocery stores, and those available were likely to have seen their prices increase.
Disruptions in the production and delivery delays came to define the supply chain management for some of the world’s largest firms. While this created limitations in supply, consumer demand was already high. What made matters worse is the panic buying situation that ensued when Covid-19 hit. Because consumers worried about not being able to find their basic necessities, they sped up their purchases, putting more pressure on prices. For a lot of products, prices rose steeply, and it wasn’t until supply chains readjusted and production picked up that prices went back to normal.
Another noteworthy example of supply bottlenecks increasing prices is that of cars. In addition to computer chips being in short supply, automakers seem to be suffering from shortages of other parts too, such as plastics and glass. This is what made car prices hit a new record.
Inflation
If recovery in the US has somehow been faster and more robust than in the EU, the Fed’s early decision to raise interest rates to stem inflation has likely had its impact on stock prices recently. The S&P 500 index has dropped by 7%, the Nasdaq and the Dow by 12% and 4.4% respectively since the beginning of 2022. However, rather than blaming these decreases on Covid-19 variants, observers have attributed the cause to inflation.
Supply chain disruptions and soaring energy prices have obviously caused prices to go up. As of this writing, price inflation rate has recorded 7.5% in the US, driven mostly by a huge increase in the prices of cars and gasoline. Wage inflation also grew 4.5% since 2020, the largest such increase since 1983, driven by labor shortages. The bargaining power in the labor market is found to be favoring workers at the expense of employers.
Economic Prospects
While this has pushed central banks to hike rates sooner and faster, the repercussions on the economy are notable. Credit markets face significant long-term uncertainties and rising prices are likely to lead to tighter financing conditions and market volatility. Currently, cheap money makes credit conditions favorable, but rising financing cost complicates spending and investment decisions. If inflation ran stronger and longer, price pressures combine with supply constraints would compel investors to demand higher returns for the risks they assume. A re-pricing of financial and real assets would ensue, with higher debt-servicing costs and tighter financing conditions.
This is bad for the economy. Emerging markets remain reliant on external financing and are thus vulnerable to volatile capital inflows, hurting their chances of financing development and maintaining stability. Because of increased costs on foreign currency borrowings, they would suffer from higher financing costs.
The most vulnerable countries are those lacking monetary sovereignty. Where the fiscal space is tight and higher interest rates rise the cost of borrowing money, debt sustainability is a real trouble. This is not the case in such monetarily sovereign countries like the US and the UK, where public debt has almost hit the same size of GDP but fiscal policies can still be utilized effectively. Even if interest rates rise to 5 or 6 percent in these countries, debt sustainability is hardly a question. While different schools of thought adopt opposing views regarding debt sustainability, the US’s recent fiscal response to Covid-19 seem to refute claims about public debt ceilings and sovereign government solvency.
