It may be time for a change in policy...
BACK IN 2008/9, chaos on global financial markets created a large recession across the world economy. But the recovery from the recession has been hampered by a different global market problem – rising and volatile energy and commodity prices, writes former Bank of England Monetary Policy Committee member Andrew Sentance.
In 2010, the world economy bounced back more strongly from recession than most forecasters were expecting. With stronger growth came higher energy and commodity prices. After dropping to about $40-45 in early 2009, the oil price rose to $75-80 in early 2010 on the way back to over $100.
Last year saw a broader-based surge in commodity and energy prices, pushing up inflation rates around the world. The squeeze on consumers reinforced the slowdown in global growth last year. And though Inflation rates peaked in most countries last autumn, the oil price is picking up again as signs of life return to the global economy – with Brent Crude up to around $125/barrel.
Looking back over the past decade, an ominous pattern is emerging. The era of relatively stable energy and commodity prices which prevailed from the mid-1980s until the early 2000s has given way to periodic bursts of energy and commodity price inflation. The first occurred in 2003-5, the second in 2006-8, and the third in 2009-11. If – as many forecasts suggest – the world economy starts to gather momentum again as we move through this year, we are set for another phase - carrying through into 2013 and possibly 2014.
This reflects the fundamental balance of supply and demand. New sources of energy supply and natural resources are costly and slow to come on stream. Meanwhile, demand is being pushed up by the activities of the 6.8 billion people now living on the planet, with the vast majority of them participating in the global economic system and aspiring to a higher standard of living. We have never been in this situation before.
We cannot guarantee, either, that the next surge in energy and commodity prices will be the last. The world economy experienced a prolonged period of rising and volatile energy and commodity prices from the late 1960s until the early 1980s. And that was in a world with a much smaller population and many fewer nations participating in the global economic system.
How should policy-makers react? Central Banks in the UK and other western economies have generally turned a blind eye to the surges in inflation created by successive waves of energy and commodity price inflation. They have done so because of other concerns (such as the financial crisis) and because they believe that inflation expectations are well anchored and underlying confidence in their ability to sustain stable prices remains intact. But continuing to tolerate phases of relatively high inflation will raise questions about this commitment to price stability.
In the 1970s, the western Central Bank which took the inflationary threat from energy and commodity prices most seriously – the Bundesbank – emerged from that period of volatility with its reputation greatly enhanced. Others, including the UK, faced a long battle against high inflation and fared less well. Currently, the focus of the western Central Banks is on combatting the aftermath of the financial crisis rather than the threat of high and rising energy and commodity prices. That judgment may have been right in 2008/9. But a renewed burst of commodity and energy price inflation - which may just be getting underway – could require a different policy approach.
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