The US helped spark a global surge in the cost of living. Now that the country’s price inflation shows signs of easing, does it point the way for the rest of the world?
The US was the first major economy where inflation took root, as a wave of pandemic relief money from the government set off a boom in activity and spending.
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The price increases soon spread overseas, as strong demand from American buyers pushed up the cost of oil and other essentials, global shipping firms raised fees, and companies faced with shortages hiked prices.
Then, when the US central bank started raising interest rates to fight the problem, it triggered a rush of money into the country, sending the dollar to its strongest level in two decades – and raising costs in other countries even more.
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The US was hardly the only force behind the sudden rise in the cost of living – the war in Ukraine also played a massive role, knocking out food supplies and disrupting energy markets, especially in Europe.
Still, analysts say that if America’s inflation problem is improving, that is good news for the rest of the world, especially if it means the central bank can ease up on its fight, allowing exchange rates to stabilise.
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“To the extent that US inflation slows, that’s going to be helpful for the inflation situation in the rest of the world,” says Maurice Obstfeld, a professor of economics at the University of California, Berkeley and a senior fellow at the Peterson Institute for International Economics.
But, he cautions, so far the price easing remains modest: “We don’t want to get ahead of ourselves.”
Easing prices for energy and goods
The latest report from the US showed annual inflation, the pace at which prices rise, was 6.5% in December. That was the smallest increase in more than a year, marking the sixth month in a row of the rate falling.
That has been driven by falling costs for used cars, appliances and other goods that were in hot demand – especially in the US – during the pandemic.
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It has also reflected global price easing, as oil markets recover from the shock of the Ukraine war, and investors bet that energy demand will fall, as economies slow due to the inflation fight.
Analysts expect even more items to benefit from lower prices in coming months, as the US economy slows and demand falls due to higher borrowing costs.
Dollar effect
The US central bank yanked its key interest rate to the highest level in 15 years in 2022, moves followed by many countries around the world.
By increasing borrowing costs, the bank was trying to discourage activity like business expansions and spending on homes and cars, and rein in the pressures pushing up prices.
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.
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For the rest of the world, which has been dealing with the historic surge in the value of the dollar sparked by the bank’s moves, analysts say the policy shift should mean relief.
“We saw this really dramatic appreciation of the dollar when the US was really moving most forcefully against inflation earlier in 2022,” says Kathryn Dominguez, a professor of economics and public policy at the University of Michigan, who notes that many companies around the world borrow and trade goods in the currency, which soared 18% in the first nine months of 2022 before starting to retreat.
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“As exchange rates stabilise, that kind of moving of inflation from one country to another is likely to abate.”
A less aggressive Federal Reserve may also ease other kinds of financial strain, by making it easier for countries in the developing world to attract investment, says Shang-Jin Wei, a professor of economics at Columbia Business School.
“When the US slows down its interest rate increases, it’s very good news for many countries around the world because higher US interest rates tend to attract capital away from Latin America, Africa, Asia,” he says.
“Countries like Argentina, Indonesia, Sri Lanka – they can breathe a sigh of relief.”
Risks in 2023
Although the Fed has said it will slow down its rate rises, the path ahead remains uncertain.
The bank has forecast that inflation in the US will fall to roughly 3% by the end of 2023 – but that’s an outlook that “seems quite optimistic”, according to Prof Dominguez.
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For now, the jobs market in the US remains strong, and workers are pushing for higher wages, which could lead to higher prices down the road.
China’s recent decision to loosen its Covid-19 policies may also add demand pressures to the global economy.
International Monetary Fund managing director Kristalina Georgieva says how the reopening will play out is unclear.
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“We know that would be a couple of tough months for China. How long would that be, and how deeply it would impact the Chinese economy and through it, Asia and the rest of the world, is still to be seen,” she told the BBC’s Talking Business programme.
If the Fed is forced to take a tougher stance than expected, that 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 inflation in the US may prove a “double-edged sword”, since it is likely to reflect a recession in the world’s largest economy.
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“That of course is going to be negative for employment and output growth throughout the world,” he says.
Ms Georgieva says she thinks the US will avoid a recession, “carried forward by the confidence of US consumers and the savings they accumulated 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, Prof Dominguez says.
“The hope is if all countries are moving in the same direction, they will not need to be as aggressive, which might then also lead to less economic slowdown across the world,” she says.
By Natalie Sherman || Business reporter, New York