Here’s why global inflation pressures may become harder to handle in coming years

Mount­ing trade bar­ri­ers, aging pop­u­la­tions, and the tran­si­tion to renew­able ener­gy sources are increas­ing­ly blend­ing to inten­si­fy the chal­lenge of man­ag­ing infla­tion. This fusion of such unwel­com­ing fac­tors threat­ens to strain the efforts of cen­tral banks, par­tic­u­lar­ly the Fed­er­al Reserve, in achiev­ing their infla­tion targets.

In a recent meet­ing of cen­tral bankers at the Jack­son Hole, a recur­rent theme emerged—rising glob­al infla­tion pres­sures and the increas­ing com­plex­i­ty of con­tain­ing them. For decades, the world wit­nessed a trend of increas­ing eco­nom­ic inte­gra­tion, fos­ter­ing the flow of goods between nations. How­ev­er, the post-pan­dem­ic land­scape is alter­ing this trajectory. 

The pan­dem­ic trig­gered a shift in sup­ply chains, with multi­na­tion­al cor­po­ra­tions diver­si­fy­ing away from Chi­na. A notable exam­ple is the redi­rec­tion of semi­con­duc­tor pro­duc­tion to the Unit­ed States, buoyed by the pro­vi­sion of $52.7 bil­lion in sub­si­dies for U.S. semi­con­duc­tor pro­duc­tion from the Biden administration.

Simul­ta­ne­ous­ly, the push towards renew­able ener­gies is caus­ing dis­rup­tions by boost­ing demand for raw mate­ri­als and dri­ving gov­ern­ment bor­row­ing, ulti­mate­ly con­tribut­ing to infla­tion. This is wors­ened by aging pop­u­la­tions world­wide, as old­er indi­vid­u­als tend to leave the work­force, cre­at­ing sup­ply con­straints akin to those trig­gered by short­ages dur­ing the pan­dem­ic recovery. 

There were 771 mil­lion peo­ple aged 65+ years glob­al­ly in 2022, account­ing for almost 10% of the world’s pop­u­la­tion. This por­tion has been grow­ing at an increas­ing rate, and it’s expect­ed to hit about 16% in 2050, and even­tu­al­ly 24% by 2100.

Chris­tine Lagarde, Pres­i­dent of the Euro­pean Cen­tral Bank, point­ed to this evolv­ing sce­nario, stat­ing: “The new envi­ron­ment sets the stage for larg­er rel­a­tive price shocks than we saw before the pan­dem­ic.” Lagarde also high­lights the vul­ner­a­bil­i­ty of mar­kets tied to com­modi­ties, par­tic­u­lar­ly met­als essen­tial for green technologies.

Such sce­nar­ios com­pli­cate the efforts of cen­tral banks—ECB, Fed, and others—charged with tam­ing infla­tion. Most cen­tral banks are grap­pling with the per­sis­tent high infla­tion that emerged in ear­ly 2021 and has only par­tial­ly subsided. 

Pierre-Olivi­er Gour­in­chas, Chief Econ­o­mist at the Inter­na­tion­al Mon­e­tary Fund, empha­sized the increas­ing dif­fi­cul­ty in pro­duc­tion due to these fac­tors, lead­ing to height­ened costs—a sce­nario that cen­tral banks find par­tic­u­lar­ly challenging.

“We are liv­ing in this world in which we could expect to have more and maybe big­ger sup­ply shocks,” said Gour­in­chas in an interview.

Lau­ra Alfaro, anoth­er econ­o­mist at Har­vard Busi­ness School, iden­ti­fied shift­ing glob­al trade pat­terns. “We are not deglob­al­iz­ing yet,” Alfaro said. “We are see­ing a loom­ing ‘Great Real­lo­ca­tion’ ” as trade pat­terns shift.

Chi­na’s share of U.S. imports sig­nif­i­cant­ly fell by 5% between 2017 and 2022, large­ly due to U.S. tar­iffs and com­pa­nies’ efforts to diver­si­fy sources. While the U.S. is import­ing from alter­na­tive nations like Viet­nam and Mex­i­co, this trend, known as “friend­shoring,” has led to increased costs. It’s essen­tial to note, though, that U.S. eco­nom­ic ties with Chi­na remain inter­con­nect­ed through var­i­ous sup­ply chains, even amid diver­si­fi­ca­tion efforts.

The sit­u­a­tion is not entire­ly grim, as fac­tors like Chi­na’s slow­er growth could ease infla­tion pres­sures. How­ev­er, uncer­tain­ties still loom large. Fed­er­al Reserve Chair Jerome Pow­ell acknowl­edged that the path ahead is uncer­tain, with inter­est rate hikes con­tin­gent on infla­tion’s trajectory. 

Experts believe that tran­si­to­ry infla­tion might take root if sup­ply con­straints per­sist, poten­tial­ly affect­ing longer-run infla­tion expec­ta­tions. Johan Grahn, head ETF mar­ket strate­gist at Allianz Invest­ment Man­age­ment said, “Pow­ell is in this posi­tion where he’s try­ing to sum­mit one of the Grand Tetons and he does­n’t do that with­out paus­ing and catch­ing his breath.”

As we draw lessons from his­tor­i­cal par­al­lels, such as post-World War II peri­ods, where sup­ply chain dis­rup­tions and pent-up demand led to tem­po­rary infla­tion spikes, it’s impor­tant to rec­og­nize the cur­rent land­scape’s unique­ness. The pan­dem­ic-induced dis­rup­tions, cou­pled with the shift towards renew­able ener­gy and chang­ing trade dynam­ics, set the stage for an intri­cate inter­play of fac­tors impact­ing infla­tion in com­ing years.