Global Economy Assignment Sample

Introduction

Inflation is one of the most familiar terms in economics that refers to the percentage change in value of WPI or “Wholesale price index” on a year to year basis. Inflation effectively measures changes of goods and services in a particular year. This essay would discuss several issues regarding global inflation rates and factors that are influencing inflation through “monetary transmission model” (MTM).

Main Body

Main difference between inflation development of EU and USA was due to stronger increases in inflation that excluded food and energy. Since 2016, global inflation rate has increased at a higher level which has impacted global economy negatively. In 2022, global inflation rate will increase by 3.81% that previous year and in next financial year, it is assumed to increase 3.3%. As measured by “US Consumer Price Index” (USCPI), by December 2021, inflation rates in US has increased by 5.6% and reached 7.0%. Energy inflation played a significant role as it made a 2.2 percentage point contribution in US inflation and 2.5% in EU inflation. Energy inflation is responsible for half of headline inflation in EU and one third in US. Inflation rates in EU and USA increased mainly because of supply disruptions and reopening of economy.

Inflation mainly occurs because of an imbalance between supply and demand of money, increasing taxes on products, distribution of cost and changes in production. Economy may experience higher inflation when prices of services and goods rise and value of currency reduces. Higher inflation generally impacts economy of a country by increasing price of goods and reducing purchasing power of consumers. Inflation impacts global economy in various ways. Due to inflation producers can sell products at a higher price and earn higher profit. Higher inflation helps in providing higher investment returns and increases production. Inflation gives better opportunity, better income and more employment.

Apart from advantages, there are certain disadvantages of inflation or higher inflation in global economy. Fixed or lower income groups including labourers, employees or pensioners face difficulties while purchasing goods as theory have a fixed income and often their income does not increase compared with inflation rates. As studied by Taylor and Barbosa-Filho (2021), inflation generates inequality in distribution of income, where capitalists earn more profit and labour suffers from price hikes. Inflation also disrupts planning process of economy and government and due to inflation speculative investments increases. It generally leaves a negative impact on capital accumulation and export income. As a result of this, lenders face huge losses. This is how inflation impacts economy in a negative way.

Generally, there are two major factors that contribute to inflation which are supply and demand. These are more of a conventional factors but current situation of COVID-19 pandemic, increasing fuel and energy price, disruption of supply chain and bounce back of economy after pandemic are major factors that are contributing to higher inflation. During initial state of COVID pandemic in early 2020, producers and manufactures of goods and services witnessed a rapid change in consumers spending pattern. This change in spending was partly because of extended lockdowns regulations implemented by governments across the world. It was the time when researchers realised that official measures of inflation might not help in capturing changes in price of products. Prior to COVID-19 pandemic, official measures of inflation intended to understate its value. Primary reason behind this was to provide excessive weightage to products that had falling prices including footwear, clothing and even petrol. During COVID, true inflation was higher than consumer price index in all regions of US and Europe and due to this many people suffered from price hikes. Keeping COVID-19 aside, supply chain disruptions and fuel price hikes have negatively impacted inflation. Disruption of supply chain and fuel price hikes increase price of final products and consumers face problems while buying those.

COVID-19 leaves a long term negative impact on inflation and various economic crises are related to it. COVID-19 disrupted supply chain management and increased fuel price. Most importantly, COVID-19 is responsible for creating a severe health crisis over economic or financial crisis. It has generated unusual disruptions including temporary business closer and stay at home regulations. This pandemic is sudden and brutal as it led to unemployment and therefore a major financial crisis. Armantier et al. (2021) stated that impact of COVID-19 can be both deflationary and inflationary as long term economic slowdown or weak consumer demand can be witnessed. Due to COVID consumer price index has fallen to 0.1%, 0.4% and 0.1% in March, April and May 2020, respectively. On the other hand supply chain disruption has triggered shutdowns and rising government debts. Due to this COVID-19 might have a long term impact on Global economy?

Monetary Transmission Model (MTM) is management tool that aims at describing and developing various ways through which changes can be made by Central Bank to supervise efficiency of its monetary policies through inflation and activity. MTM process is complex and it also has uncertainty regarding time and impact of economy. Monetary transmission model can be summarised in two stages: first, m monetary policy changes that affect interest rates within a certain economy and second, changes in interest rates that affect inflation and other economic activities. MTM also helps in controlling liquid cash in market and maintain adequate inflation. Monetary policies in countries are determined by central banks and in US monetary policies are control by Central bank of USA or Federal Reserve System (Bernanke 2020). Central banks implement monetary policies to determine several economic factors such as cash rates, quantity and price of government bonds, and low-cost fixed term findings in different financial institutions.

In first stage of MTM central banks aim at making an influence on interest rates in economy by introducing changes within monetary policies. Primary aim of influencing interest rates is to control cash rates. Cash rates are regarded as interest rates for overnight loans between banks or other financial institutions (Vallence and Wallis, 2021). These loans leave a major impact on interest rates including lending and deposit rates for businesses and households. In MTM, other monetary policies affect long term interest rates within economy and helps in reducing inflation. In second stage, monetary transmission is mainly about bringing changes in monetary policy that would influence inflation and economic activities. Second stage of monetary transmission is executed by following two strategies including aggregated demands and inflation expectations. In aggregate demand, central banks reduce interest rates by stimulating spending of consumers Manasseh et al. (2018). In second factor, central bank identifies expectation of consumers to control inflation. For instance, if workers or labourers expect inflation to be increased, they would directly ask for increase in their wage. Thus higher growth of wage and salary would lead to higher inflation.

International Monetary Fund has identified two main policies for controlling higher inflation that includes foreign currency exchange policy and macro prudential policies. However, most appropriate policy for controlling inflation is to sell government bonds (Castillo-Martinez and Reis, 2019). By selling government bond central banks would be able to collect liquid cash in market that leads to higher inflation in economy.

Global Economy Assignment Sample

Conclusion

This study has discussed about inflation has both positive and negative impact on economy but most importantly, controlling inflation is required to build a strong economy. High inflation is developed by supply and demands and other contemporary factors. It has been understood that proper inflation management policy such as monetary transmission policy helps in controlling inflation by bringing new strategies such as foreign exchange and selling government bonds.

References

Ambrocio, G., Ferrero, A., Jokivuolle, E. and Ristolainen, K., (2022). What should the inflation target be? Views from 600 economists. Views from, 600.

Armantier, O., Koşar, G., Pomerantz, R., Skandalis, D., Smith, K., Topa, G. and Van der Klaauw, W., (2021). How economic crises affect inflation beliefs: Evidence from the Covid-19 pandemic. Journal of Economic Behavior & Organization, 189, pp.443-469.

Bernanke, B.S., (2020). The new tools of monetary policy. American Economic Review, 110(4), pp.943-83.

Castillo-Martinez, L. and Reis, R., (2019). How do central banks control inflation? A guide for the perplexed. LSE manuscript.

Echarte Fernández, M.Á., Náñez Alonso, S.L., Jorge-Vázquez, J. and Reier Forradellas, R.F., (2021). Central banks’ monetary policy in the face of the COVID-19 economic crisis: Monetary stimulus and the emergence of CBDCs. Sustainability, 13(8), p.4242.

Manasseh, C.O., Abada, F.C., Ogbuabor, J.E., Onwumere, J.U., Urama, C.E. and Okoro, O.E., (2018). The effects of interest and inflation rates on consumption expenditure: Application of consumer spending model. International Journal of Economics and Financial Issues, 8(4), p.32.

Taylor, L. and Barbosa-Filho, N.H., (2021). Inflation? It’s Import Prices and the Labor Share!. International Journal of Political Economy, 50(2), pp.116-142.

Vallence, C. and Wallis, P., (2021). The Response by Central Banks in Advanced Economies to COVID-19. RBA Bulletin, December, viewed January.

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