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.