It is not as simple as that with commodities though, as they cannot really be manufactured anywhere, only in the areas where the commodity already exists, and while there is some elasticity – that is, some ability for commodity producers to increase output from existing sites – this takes time.
While higher interest rates do not, in themselves, address the supply shortages, the hope, says Moec, is that it would be interpreted by markets as a sign that central banks are dealing with inflation and so push expectations around the future rate of inflation lower.
While Moec was relatively sanguine about the economic outlook prior to the Russian invasion of Ukraine, he says he now feels a recession in Europe is possible, due to the impact of the higher inflation on the spending power of the poorest.
If inflation comes from the demand side, it is typically accompanied by higher GDP growth, but supply-side inflation has a negative impact on GDP growth, as it reduces spending power.
A scenario where inflation is persistently high, but economic growth is declining, or even negative, is called 'stagflation'.
Stagflation nations
Gero Jung, chief economist at Mirabaud, quantifies the impact by saying that every time inflation rises by 10 per cent (eg from 3 per cent to 3.3 per cent), that is sufficient to reduce GDP growth by 0.2 per cent.
Policymakers presented with what may be stagflationary conditions are therefore presented with a choice: to either attempt to push the inflation downwards, or the growth upwards.
If policymakers feel the inflation is shorter term, as is often the case with supply-side shocks, then they may choose to focus on pushing up the level of economic growth.
This may lead to demand-side inflation arriving just as the supply-side factors dissipate, but central bankers are much more confident in their ability to use monetary policy to curb demand-side inflation, while the wider economy and society benefit from the higher level of economic growth.
It is for this reason Jung is not so sure that stagflation will be the inevitable consequence of the Ukraine conflict, as he feels government spending will be higher, and this could boost economic growth.
Jung, German by origin, says the new commitments to increase spending on defence by that country’s government are likely to act as a stimulus to economic growth, and such a stimulus is likely to be repeated in a number of other countries in response to the crisis in Ukraine, and boost economic growth.
Keith Wade, chief economist at Schroders, says the reliance of the Eurozone on imported Russian energy means “it will be at the epicentre of any stagflation. It looks now like that is where we are headed".
