The contractor | Six questions about inflation: it gets worse first …

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Inflation is through the roof. And there’s a really good chance it’s going to stay that way for now. Can we get rid of it and who pays the bill?

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December 12, 2021

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In November, inflation in the Netherlands rose to 5.2 percent, the highest level in forty years. On Budget Day, the government announced a slight improvement in the purchasing power of the entire population. But it also calculated with inflation that would remain below 2 percent. It is still unclear how high inflation will actually be, but it is certain that it will be more than 2 percent, AD informs.

Workers can still try to get extra pay during the negotiations on a new collective agreement. But retirees and people who depend on benefits are still the losers. Most pensions remain frozen, so the entire price increase is at the expense of their purchasing power. It is therefore logical that there are already voices in politics to improve the purchasing power of citizens. Whether that happens is up to the new cabinet, and that is not yet the case.

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1. Where is inflation?

If you look at the basket of products and services that the Central Bureau of Statistics (CBS) uses to measure inflation, you see that almost everything becomes more expensive. Energy, especially gas, has become significantly more expensive. But clothes and groceries are also rising above average.

2. Where does this inflation suddenly come from?

It has two reasons. On the one hand, demand is rising again. And on the other hand, the offer is faltering. More demand than supply leads to higher prices, so simple it is.

Let’s take clothes as an example. During the shutdown, there was little demand for clothing. As the economy reopens, demand rises. But the supply of cotton, the raw material for many garments, did not increase. Cotton therefore became more than 40 percent more expensive between June and November this year. A lot of clothes come from Asia and are transported by sea container. Tariffs for container transport have increased sixfold this year. Here again, the supply of containers and ships could not keep up with demand. It is therefore logical that clothes become more expensive.

And so it is with many products. More production also leads to more demand for oil, gas and electricity. When economies declined in 2020 due to shutdowns, no oil company invested heavily in new production. Now that demand is picking up again, countries and companies are bidding on each other to get enough energy.

More expensive gas means higher heating costs, but also makes electricity more expensive because many power plants are gas-fired. So inflation is increasingly creeping into prices.

Read also: Bankruptcies worldwide increase by 15 percent in 2022, Netherlands: +34 percent

3. How does it work then?

We notice at the pump that petrol is more expensive. But that expensive gasoline also affects transportation rates. And transportation accounts for an average of 6 percent of the cost of a product.

To stick with oil for a moment: Many plastics are made from oil, such as packaging film. Packaging materials are becoming more expensive and transportation is becoming more expensive. In this way, the price increase affects more and more parts of the price. And that’s not all.

4. What else is involved?

Trucks are also becoming more expensive. Trucks have e.g. more and more shavings. There is also a lack of that, which drives up the price. And anyone who thinks they are smart about buying a used car will be disappointed. Prices for apartments are also through the roof.

Most economists and monetary authorities still assume that high inflation is temporary. But temporarily, it takes longer and longer. Once the production of raw materials and parts starts and the disruptions in the logistics are resolved, the problem is soon over.

5. Inflation: what else can we expect?

Still many problems, is the fear. Many manufacturers have not yet overturned all cost increases because they are first waiting to see if prices stay high for a long time. These higher costs are expected to be passed on to consumers in the coming months.

Most economists and monetary authorities still assume that high inflation is temporary. But temporarily, it takes longer and longer. Once the production of raw materials and parts starts and the disruptions in the logistics are resolved, the problem is soon over. More supply and more security for timely delivery will lead to lower prices, they claim. Companies are now trying to buy as much as possible, just to be sure of delivery. Because without stock, the factories come to a standstill. This feverish purchase pushes up the price even more.

But now there is a growing fear that the disruptions in production and logistics are far from over. For example, China shuts down entire industrial areas and ports if there are single corona cases. And that immediately means nothing to buyers in the West. And the corona is proving to be more persistent than expected.

Read also: Fewer exporting companies suffer from the effects of the corona crisis

6. Can anything actually be done about this inflation?

The best remedy for high prices is high prices. The inflation we are seeing now is primarily imported inflation. Raw materials and products that we get from abroad are more expensive. Doing nothing is a solution. High prices affect purchasing power. That means we can buy less. So demand is falling. And less demand leads to lower prices. Then inflation collapses under its own weight, as Rabobank describes it in a recent study.

Another option is to protect purchasing power by raising wages. You can already see it happening in the United States. This is less the case in the Netherlands because wages are set in long-term collective agreements. By raising wages, you risk a wage-price spiral. Higher wages lead to higher costs and therefore more expensive products. This in turn leads to higher wages and so on. Then you have turned inflation into a domestic problem.

And that problem can be combated again by raising interest rates so that the economy cools down. Then prices no longer rise and so do wages. But a cooling economy means higher unemployment.

So yes, there is something to do about inflation, but it will not be painless.

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