At the beginning of 2020, governments around the world faced very difficult challenges and decisions.
What were they supposed to do?
Let people make their own decisions, knowing that this would have a dramatic impact on Covid related deaths?
Or impose lockdown restrictions, reducing the amount of deaths, but producing a serious impact in the economy?
Neither option was without consequences, and we now know that most governments around the world chose the second option.
So let’s explore the consequences that this had on the global economy.
The first one, and most immediate one, was a reduction in private spending. As people were forced to stay at home, their spending options were limited (although to be fair this came alongside a huge growth in online spending habits).
Then came a dramatic increase in public spending, in the form of private and business subsidies.
And with that… the question in everyone’s minds: how are governments going to afford all these subsidies?
Financing Public Spending
Which brings us to the question at hand: how were governments able to afford the subsidies?
Well.. let’s explore this for a moment.
There are only three ways that governments can fund themselves:
- Tax revenue
- Borrowing (Debt)
- “Print more money” (or the more technical term Quantitative Easing)
Tax Revenue
‘Most of us understand tax revenue. So we won’t spend too much time dwelling on this one. Suffice to say that when the economy contracts, increasing tax pressure on the private sector is a recipe for recession, so this was not an option.
Borrowing
Then comes borrowing, and many governments took as much debt as they were able to.
For example, in the 2021-2022 financial year, the UK alone borrowed £143.7 billions according to the Office of National Statistics.
By June 2021, New Zealand’s government had borrowed NZD$ 6.6 billions.
Australia borrowed an unprecedented debt amount estimated at AUD$ 400 billions, taking their debt to GDP rate from 20% to 40%.
But these amounts of money were not enough to satisfy the spending demands of governments during the pandemic, which leads us to the third “funding” method and the most controversial one.
Quantitative Easing (or “printing money out of thin air”)
Quantitative easing sounds complicated, but it’s actually pretty straightforward.
It basically means that the government buys back government debt (in the form of bonds), therefore increasing the value of said bonds and reducing the interest rates.
With lower interest rates, money becomes cheaper, therefore more lending is encouraged.
In short, QE is a way to increase the amount of money circulating in the economy.
It’s the kind of economic policy measure you would take if you were trying to get the economy moving at a faster pace.
And (pay attention here) is the exact opposite of what you would do if you were trying to reduce inflation, or avoid it altogether.
And here comes the million dollar question (or should I say the Billion dollar question?):
How much QE can you get away with, until you face the wrath of inflation?
This is a long standing debate between orthodox and heterodox economists (or Conservatives vs. Keynesians), and we are nowhere near settling the dispute.
And while we are trying to figure this out, here comes geopolitics to create the perfect storm.
War in Europe And The Rising Cost Of Food And Energy
The war in Ukraine comes with a dire consequence to the rest of Europe, UK, and the rest of the world.
Russia being Europe’s main energy supplier and Ukraine’s being Europe’s main food supplier, it’s not difficult to explain the grave consequences that this conflict has in the rest of the European economies.
The obvious (and direct) consequences are the rise in the cost of petrol and food.
But what about the indirect consequences?
Virtually every good and service in the economy requires two main supplies: food and energy.
Think about it… it’s not just the grocery and the service station bill. It’s everything else. Even a lawyer needs to eat and drive a car. So does the dentist, the store clerk, the school teacher and everyone else that participates in the economy.
The indirect consequence is a rise in costs in every chain and in every layer of the economy. Some businesses are able to absorb these increased costs, and some have no choice but to pass it on to their customers.
What Can We Expect In The Future? Is Inflation Here To Stay?
The answer to this question largely depends on the economic policies that governments are likely to adopt in the coming months and years.
Are they going to keep expanding the economy’s circulating currency so that people have higher wages and can afford rising costs of living?
This could become a slippery slope, and a self feeding loop with dangerous consequences, as more circulating currency creates pressure on prices, which triggers more inflation.
Or are they going to “bite the bullet” so to speak… and let their electorate deal with the consequences of inflation without taking alleviating measures?
The former seems unthinkable from a politicians perspective, while the latter could create even more economic trouble long term.
Only time will tell. In the meantime, it seems prudent not to discard a future with lingering (and maybe growing) rates of inflation.
Erin Sutton is an online blogger and writer, publisher of Best Catalogues, an online publication that helps UK shoppers make better and informed decisions related to spending and taking credit.
