Central banks of many emerging markets are overshooting their inflation goals, as prices of essential goods and services - from flour, to cooking oil, energy, and gasoline – continue to rise. Supply chain disruptions due to COVID-19 and the war in Ukraine are all compounding inflationary pressures. It is increasingly feared that the 1970s will repeat themselves, when global inflation got out of control, spiking to almost 14% by 1980. Or even worse, that those countries with an already double-digit inflation could fall into hyperinflation, as was the case in Latin America for much of the 1980s and early 1990s.

Persistent inflation is quite damaging for an economy and has high social costs. Surging prices of goods and services have a high impact, especially on low-income households, as these have fewer possibilities to adjust their spending patterns and limited savings to compensate the loss of purchasing power. With the new high in global food prices of 34% yoyin March, the poor are at high risk of food insecurity.

But long-lasting inflation also hurts small businesses since they are not always able to pass on higher input prices to the end-consumer, thus resulting in lower profits. When inflation expectations derail, it is more difficult to plan, given the uncertainty in wage negotiations and the currency depreciations that follow, impacting trade-related businesses. High inflation is also a bad advisor when it comes to elections, with citizens often choosing the quick but usually unrealistic fix that populist leaders promise.

Usually, all eyes are set on central banks to tame inflation. During the past two decades emerging markets have shown that rate hikes are more effective if done in a transparent manner, in an environment of rules-based fiscal decision-making and in countries with higher credit ratings. In 2021, central banks in many emerging markets - with the exemption of emerging Asia and South Africa - have raised interest rates in preparation for Fed rate hikes. And many continued to do so in 2022, with central banks of countries near the epicentre of the war raising rates aggressively over the past few months.

But now that inflation pressures are being fed by a mix of demand buoyancy and supply-side disruptions and central banks normally fight high prices by constraining demand pressures through higher interest rates. Leaving it to central banks alone to solve the challenge of containing inflation may well result in volatile economic growth and a period of stagflation (high inflation and low growth or even a recession).

Governments also try to mitigate the impact of inflation pressures by turning to subsidies and lower taxes to dampen the impact of higher prices of essential goods and services and in extreme cases using wage and price controls. However, this often results in unwelcome price distortions that are sometimes difficult to reverse.

With COVID-19 and the changes in the geopolitical landscape that are pushing up prices through disrupted supply chains, other options need to be considered. The US has unleashed part of its strategic oil reserves, which at least for now is contributing to reduce the pressure on oil prices. It will also help to push the production of renewable energy, to become less vulnerable to swings in oil and gas prices. This may have some immediate consequences for input prices, but in the long run, the benefits are huge on many fronts.

Indeed,higher diversification reduces inflation pressures when multiple countries are hit by supply shocks. However, there are still no signs that global wheat production will increase in the near-term to compensate for the fallout of exports from Russia and Ukraine. In the first quarter cereal prices alone have increased by 37% yoy. Finally, more efforts will also have to be channeled into making logistics and shipping more resilient. 

We cannot leave it to central banks alone to deal with inflation. So, striking the right balance in policies, including supply-side solutions and more focus on renewable energy production is critical. In such challenging economic circumstances, a concerted and balanced effort by central banks, governments and the private sector is required.