The US helped trigger a global increase in the cost of living. Now that the country’s price inflation is showing signs of easing, does it point the way for the rest of the world?
The US was the first major economy to see inflation take hold, as a wave of government pandemic relief funds sparked a boom in activity and spending.
The price hikes soon spread overseas as strong demand from American buyers drove up the cost of oil and other essential commodities, global shipping companies hiked fees, and companies facing shortages hiked prices.
Then, when the Federal Reserve began raising interest rates to combat the problem, it triggered a flow of money into the country that sent the dollar to its strongest level in two decades – and pushed up costs in other countries even further drove.
The US wasn’t the only driver behind the sudden rise in the cost of living – the war in Ukraine also played a massive role, shutting off food supplies and disrupting energy markets, particularly in Europe.
Still, analysts say an improvement in America’s inflation problem is good news for the rest of the world, especially if it means the central bank can ease its fight and allow exchange rates to stabilize.
“To the extent that US inflation slows, it will help the inflation situation in the rest of the world,” said Maurice Obstfeld, an economics professor at the University of California, Berkeley, and a senior fellow at the Peterson Institute for International Economics.
But so far the price reduction has been modest, he warns: “We don’t want to rush things.”
The latest report from the US showed that annual inflation, the rate at which prices are rising, was 6.5% in December. That was the smallest increase in more than a year and marked the sixth consecutive month the rate had fallen.
This is due to falling costs for used cars, appliances and other goods that have been in high demand during the pandemic – particularly in the US.
It also reflects the fall in global prices as oil markets recover from the shock of the Ukraine war and investors are betting that energy demand will fall as the economy slows amid the inflation struggle.
Analysts expect more items to benefit from lower prices in the coming months as the US economy slows and demand falls due to higher borrowing costs.
The US Federal Reserve raised interest rates to their highest level in 15 years in 2022, followed by many countries around the world.
By raising the cost of borrowing, the bank tried to curb activities such as business expansion and spending on houses and cars, and to curb price pressures.
But last month it said it would stop raising rates so aggressively as officials try to avoid an unnecessarily severe economic slowdown and gamble that much of their work is done.
For the rest of the world, struggling with the historic rise in dollar value sparked by the bank’s moves, analysts say the change in course should bring some relief.
“We saw this really dramatic appreciation in the dollar when the US was really at its most aggressive in fighting inflation in early 2022,” says Kathryn Dominguez, a professor of economics and public policy at the University of Michigan, who does the same for many companies around the world notes borrow and trade commodities in the currency, which surged 18% in the first nine months of 2022 before beginning to decline.
“As exchange rates stabilize, this kind of inflation shifting from one country to another is likely to diminish.”
A less aggressive Federal Reserve could also alleviate other types of financial stresses by making it easier for countries in developing countries to attract investment, says Shang-Jin Wei, a professor of economics at Columbia Business School.
“If the US slows rate hikes, that’s very good news for many countries around the world because higher US interest rates tend to pull capital out of Latin America, Africa and Asia,” he says.
“Countries like Argentina, Indonesia, Sri Lanka – they can breathe easy.”
Although the Fed has announced that it will slow its rate hikes, the way forward remains uncertain.
The bank has forecast that U.S. inflation will fall to around 3% by the end of 2023 — but that’s a forecast Prof Dominguez says “seems pretty optimistic.”
For now, the US job market remains strong and workers are pushing for higher wages, which could lead to higher prices down the road.
China’s recent decision to ease its Covid-19 policy could also increase demand pressures on the global economy.
International Monetary Fund executive director Kristalina Georgieva says how the reopening will work is unclear.
“We know it’s going to be a tough couple of months for China. How long that would take and how deeply it would affect the Chinese economy, and by extension Asia and the rest of the world, remains to be seen,” she told the BBC’s Talking Business programme.
If the Fed is forced to take a tougher stance than expected, it could affect exchange rates and borrowing costs in other countries as other central banks feel pressure to follow suit.
Meanwhile, Prof Obstfeld warns that relief from lower US inflation could prove to be a “double-edged sword” as it likely reflects a recession in the world’s largest economy.
“Of course, that will have a negative impact on employment and output growth around the world,” he says.
Ms Georgieva says she believes the US will avoid a recession “driven by US consumer confidence and the savings they have amassed during the Covid lockdowns”.
Hopefully, the fact that countries are united in their fight against inflation will make it more successful and less economically damaging than people expect, says Prof. Dominguez.
“The hope is that if all countries move in the same direction, they don’t have to be as aggressive, which could then also result in less economic slowdown around the world,” she says.
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