The last few years have been like a foggy, fading memory, from the Covid-19 pandemic to the US Capitol attack in 2021 to Russia’s invasion of Ukraine in 2022. Who would have thought about these events’ disastrous effects on our lives?

And with not much relief from the dire repercussions of the last three years, the impact of these events on our lives continues in 2023 as well.

What does this mean for the world economy?

I am not an economist. I work and run a family. But I understand simple economic terms and their co-relationships. I can do the math when I see increasing grocery bills, and my household income remains unchanged. I feel the pinch on my wallet, and I know I cannot afford to indulge in any ‘extra’ luxuries anymore as I have bills to pay and ends to meet.

In layperson’s terms, the 2023 economy can be described as a chain reaction of the following events:

Spiked inflation levels – Raised interest rates – Fall of GDP/economic growth – Fear of spreading recession

Let’s understand what inflation is.

Inflation is a measure of the rate at which the general level of prices for goods and services rises, and purchasing power falls. Various factors, including economic growth, interest rate changes, and supply and demand shifts, can cause inflation.

Common causes of inflation

1. Economic growth: There is an increased circulation of money as a country’s economy grows and expands. This increased money supply can increase prices as businesses raise prices to take advantage of the extra demand. Additionally, wages tend to rise as the economy grows, which can contribute to higher prices.
2. Changes in interest rates: When interest rates are low, it is cheaper for businesses and individuals to borrow money, which can increase spending. This increased spending can cause prices to rise as companies raise prices to take advantage of the extra demand. On the other hand, borrowing becomes more expensive when interest rates are high, leading to decreased spending and lower prices. 
3. Shifts in supply and demand: When demand for goods and services is high, businesses may raise prices to take advantage of the extra demand. Conversely, companies may lower their prices to attract customers when demand is low. Additionally, when the supply of goods and services is low, prices may rise due to the limited availability of goods and services. On the other hand, when the supply is high, prices may decrease as businesses try to attract customers.
4. Natural disasters, wars, and government policies: Natural disasters can lead to higher prices for goods and services as businesses struggle to keep up with the extra demand. Government policies, such as printing money or increasing taxes, can also lead to inflation. Wars can cause inflation as governments increase spending to fund the war effort.
   
   Understanding the causes of inflation is essential to manage its effects on the economy better.

Types of Inflation

1. Cost-push inflation: This occurs when production costs increase, leading to higher prices for goods and services. For example, if the cost of raw materials or labour increases, businesses may pass on those costs to consumers through higher prices. This can also happen due to increases in taxes, tariffs, and regulations.
2. Monetary inflation: This occurs when there is an increase in the money supply, which can lead to higher prices as more money chases the same amount of goods and services. This can happen if a central bank, such as the Federal Reserve, increases the money supply through monetary policy.
3. Expectations of inflation: Inflation can also occur if people expect prices to rise. This can happen if they think that the economy is growing too quickly, interest rates will increase, or due to any other reason. If people expect prices to rise, they may start to spend more money now, which can lead to actual inflation.
4. Imported inflation: This can happen when a country experiences inflation due to the increased prices of imported goods. For example, if the value of the country’s currency decreases, imported goods will become more expensive, leading to higher consumer prices.
5. Foreign inflation: This refers to the inflation that occurs in a country due to inflation in other countries. For example, if a country’s main trading partners experience inflation, it may increase the prices of imported goods and services, which in turn can cause inflation in the country.
   

How inflation can be controlled

1. Monetary policy: Central banks, such as the Federal Reserve in the United States or the European Central Bank, can control inflation by manipulating interest rates. When interest rates are high, borrowing becomes more expensive, decreasing spending and lowering prices. On the other hand, borrowing becomes cheaper when interest rates are low, leading to increased spending and higher prices. Central banks can also use other monetary policy tools, such as open market operations, to control inflation.
2. Fiscal policy: Governments can also control inflation by using fiscal policy, which includes government spending and taxation. For example, if the government increases taxes, it can decrease spending, which can help reduce inflation. On the other hand, if the government increases spending, it can increase demand for goods and services, which can cause prices to rise.
3. Supply-side policies: Governments can also use supply-side policies to control inflation. For example, suppose the government reduces regulations and taxes. In that case, it can make it easier for businesses to produce goods and services, increasing the supply of goods and services and helping to keep prices low.
4. Incomes policies: Governments can also control inflation by using income policies, which aim to control wage and price increases. For example, the government can impose wage and price controls, which can help to keep prices low. 
5. International coordination: Inflation can also be controlled through international coordination. For example, if a country’s trading partners are experiencing high inflation, it can increase the prices of imported goods and services, which in turn can cause inflation in the country. In such cases, governments can coordinate with other countries to stabilize prices.
   

Inflation can have various economic effects, such as reducing purchasing power, making exports less competitive, and increasing the risk of recession. Central banks and government try to balance stable prices and economic growth. It’s essential to understand the causes of inflation to create policies that can mitigate its adverse effects and maintain economic stability.

Controlling inflation is not always easy and can have negative consequences, such as reducing economic growth, increasing unemployment, and creating imbalances in the economy. Therefore, central banks and governments usually aim to balance stable prices and economic development and use different tools and policies to achieve that balance.

It seems like inflation is here to stay in 2023 for most of us from a global perspective, as the underlying problem of imbalances in the supply chain persists. And world leaders have thought of reducing overall economic activity as the answer to the inflation problem. And as the ripple effect stems from reduced spending, a recession is soon knocking on our doors. Watch this space as I discuss the recession in next week’s blog.