This year’s inflation will be on and about 8%. This is the highest the inflation has been since the 70s. In a recent publication on inflation scenarios, the Dutch Central Planning agency explains why they think that the inflation will quickly decline. Ivo Arnold, Professor of Monetary Economics at Erasmus School of Economics, warns for this positivism (20 July 2022).
Supply and demand shocks
The Professor reasons that the high inflation we are now facing is partly due to an unfortunate combination of supply and demand shocks. The pandemic and the war in Ukraine are, amongst others, responsible for the shocks. The CPB assumes that these shocks will fade out. Arnold agrees that this assumption is realistic, however, he stresses that new shocks are not unthinkable in our – currently very unpredictable - world.
Prudent behaviour and a stable hand
Moreover, the CPB assumes prudent behaviour in collective wage bargaining and a stable hand from the European Central Bank (ECB).
Arnold warns that there is no guarantee for this prudent behaviour. If employers can pass on higher wages in their prices, they will not fail to do so. And if inflation remains high, it will not just be a one-off wage increase. All the more so since different Eurozone countries have different price compensation agreements in their collective agreements. For example, more than 50% of Spain’s collective agreements contain an automatic price compensation clause. This may lead to agitated Dutch employees demanding higher wages.
Stable hand from the European Central Bank (ECB)
Furthermore, the Professor deems it unlikely that the ECB will conduct sound monetary policy. The ECB has not been in these kinds of situations before, the inflation has remained low so far mainly due to the price-depressing influence of globalisation than to the ECB's policies. Additionally, he questions whether it is realistic to expect the ECB to raise interest rates sharply when Europe has just recovered from the corona crisis, is weighed down by mountains of debt, is experiencing the worst energy crisis since the 1970s and is facing political tensions among member states.