The threat of high inflation is now looming large on the horizon not only for Indonesia but also for other countries. After being hit by a most severe recession in 2008-2009, the world economy is now already on the path to recovery, although the pace of that recovery differs from country to country.
The damages caused by the global financial crisis have not been entirely repaired, but there is growing confidence among policymakers, businesses and consumers that the world economy is regaining its feet, albeit slowly.
The mending of the economy is not fully complete, yet many countries have to deal with another threat: The re-emergence of an inflationary spiral, which if not dealt with promptly and correctly, could produce more painful economic and social impacts.
During the 1970s, the world economy was gripped by high inflation after oil prices quadrupled in the aftermath of the war in the Middle East and the Iranian revolution. Inflation ran at double-digit levels in many countries.
For the developed countries, double digit inflation was something unprecedented since World War II.
The policy responses by the developed countries were too harsh, pushing the world economy into recession and stagnation.
The world economy was faced with a new kind of phenomenon called “stagflation”, a situation where economic stagnation runs in concurrence with high inflation.
But for the last two decades inflation rates have come down substantially. In the US inflation dropped from 15 percent in 1980 to 3-4 percent since 2000.
In the developing countries, inflation averaged 50 percent annually in 1989-1998. By 2006, inflation was 5 percent. This has brought economic stability in the world, producing sustained economic growth, higher income and prosperity.
During this period most countries only experienced mild inflation, and the incidence of double-digit inflation — previously the hallmark of many developing countries — was very rare.
The only exception was probably in Zimbabwe, where the inflation rate hit 1,000 percent recently at the peak of its political crisis.
Economists attributed the decline in global inflation to two significant forces: the fall of trade barriers and the fall of the Berlin wall.
As free trade was adopted by more and more countries, trade barriers — both tariff and non-tariff — fell all over the world, bringing down the price of goods and services.
In the meantime, rapid technological developments in transport and communications in the last decade helped drive down the cost of transportation of goods and services.
The fall of the Berlin wall in the late 1980s accelerated the downfall of the Soviet Union, giving birth to several new states. Millions of people from these new countries emigrated to Western Europe and the United States.
These immigrants flooded the labor market, bringing down labor costs in those countries. But the impact of these two great developments on inflation is declining, as the move to further free trade is facing many hurdles and the influx of migration from the former Soviet republic subsided. Forces that hold down inflationary pressures are losing their strength.
Meanwhile, as the impacts of the financial crisis drove the threat of inflation far away, the concerns of the impacted countries turned to how to avert deflation. At this stage, deflation is perceived as a threat that contains more perils than inflation.
The experience of Japan provided painful lessons on how hard it is for an economy to get back on its feet once it has been strangled by deflation. No country wants to suffer the lost decade that Japan endured.
But policy responses by the developed economies during the recent crisis have planted the seeds of inflationary pressures.
Huge liquidity that has been pumped into the financial system, coupled with fiscal deficits, would be inflationary, once economic recovery takes hold. Higher commodity prices would exacerbate these inflationary pressures.
The price of oil price is nearing US$100 per barrel, and in the short-term there seems to be no force that can reverse the trend.
Emerging economies have also started experiencing inflationary pressures. Unlike developed economies where overly loose monetary conditions set the stage for inflationary pressures, in emerging economies inflation is more the result of rises of food and commodity prices.
As more and more people in these countries enjoy higher standards of living, their demand for food escalates and becomes more varied, pushing upward pressure on food prices. Unfortunately, the increase in food production lags behind the growing demand.
Worse, food production has been subject to disruptions from weather anomalies. Drought, dry weather, and floods have either delayed or damaged grain harvest in the US, Russia, Australia and other grain producing countries.
The price of rice, wheat, corn and edible oils have surged by 50 percent in recent months. Whether this weather related supply disruption is temporary or not, nobody can predict.
But the surge in demand for foods would stretch the available supply to its limit, and it would take some time to fix it.
So all signs indicate that a reemergence of inflation is imminent.
The era of declining global inflation is coming to an end. For the middle class this price surge has little impact on their cost of living. But for millions of poor people who live on US$1 or $2 a day, and who have to spend two thirds or more of their income on foods the impact would be devastating.
The response of policymakers to these impending inflationary pressures has been varied. China and India have employed a pre-emptive strike method by raising interest rates early on to staunch the inflationary threat.
The market has been given firm signals from the authorities in their resolve to contain inflation, thus ending uncertainties.
Meanwhile, Bank Indonesia, the Indonesian central bank, prefers to use a more cautionary approach, by delaying any interest rate increase on the grounds that core inflation is still within the tolerable limits. It has used a non-interest policy, by absorbing excess liquidity.
For the policymakers the immediate question is whether tightening monetary policies would be the appropriate response for the kind of inflation that is caused by supply shocks and disruptions.
Tightening monetary policy could stem inflationary expectations, but the economic slowdown that would result would also hurt the poor more than others.
The writer is an economist.
