What is inflation?
Inflation usually refers to the ‘consumer price index’: how much more expensive life has become for the average consumer compared to the previous year. In the past, Statistics Netherlands (CBS) actually visited thousands of stores to record price changes. Today, they mainly work with transaction data that companies forward and price changes in online stores that they register automatically.
For example, CBS says it keeps track of millions of price changes. Based on this, they calculate one percentage, which approximates how much money consumers spend on average more for the same goods and services than a year earlier. In doing so, they take purchasing behavior into account: if consumers spend less on catering, Statistics Netherlands will weigh the price increase of a cup of coffee less heavily in the inflation figure.
How exceptional is current inflation?
Statistics Netherlands has never recorded such high inflation as now. Double-digit percentages last occurred in the 1970s. As now, increased energy prices were largely at the root of this: the oil-producing countries demanded more for their goods at the time, driving up energy prices.
Two inflation figures are important, which have been calculated in different ways: European figures and Dutch figures. The main difference is that the costs of living in an owner-occupied home are taken into account in the Dutch calculation method, but not in the European one.
According to a first estimate using the European calculation method, prices were lower in September 17.1 percent higher than in the same month a year earlier. The Dutch inflation figure for September will follow on 6 October, which will be slightly lower. In August, the percentage according to the Dutch calculation method was 12 percentand according to the European 13.7 percent.
Why is inflation so high?
Inflation already started to rise in 2021, when the economy recovered faster than expected after the corona crisis. Companies, which had often reduced their production during the crisis, were unable to keep up with the enormously increased demand. Meanwhile, supply chains, such as shipping container shipping, had been thrown into disarray by the lockdowns. This created shortages of fuels and computer chips for electronic devices, scarcity that pushed up prices.
Leading economists, including from the European Central Bank (ECB) and the International Monetary Fund (IMF), believed this inflation would be short-lived. Whether they were right, we will never know because of the Russian invasion. Grain and fertilizer shortages arose, and energy prices rose even more in Europe due to Russia cutting back on gas supplies.
Increased energy prices account for roughly half of the inflation rate. But other prices are also rising rapidly. For example, food, beverages and tobacco cost more than 10 percent more last September than a year earlier, according to European figures. This is partly because companies pass on the high energy costs and because of the scarcity of raw materials. Other factors also continue to play a role, such as the ongoing Chinese lockdowns and the hindrance of shipping on European rivers due to the drought.
Is inflation always a problem?
No, most central bankers even consider a little inflation desirable: they usually aim for 2 percent. They want to avoid the opposite of inflation, deflation. In that case, money becomes more valuable. That sounds nice, but leads to consumers and companies leaving their money in the bank, which can cause the economy to come to a standstill. In addition, debt automatically shrinks due to inflation, which certainly came in handy in the eurozone for governments that have borrowed a lot.
When inflation is high, problems do arise. The most vulnerable part of the population immediately ends up in financial misery. Due to sharply increased prices for energy and groceries, helpline lines are already reporting much greater congestion than last year due to people who can no longer pay the bills.
Others will have less money left over and, for example, eat out less often or postpone the purchase of a car or new washing machine. As a result, some sectors turn down less turnover and have less left over for investments or hiring new staff, which is bad for the economy.
What is the wage-price spiral and should we fear it?
In this economic doom scenario, companies pass on higher wages into higher prices, which in turn lead to greater wage demands, which in turn results in higher prices. And lo and behold: a seemingly unstoppable spiral of rising prices.
That’s how it was in the 1970s. At the time, automatic price compensation (apc) was a standard part of most collective labor agreements: wages automatically rose in line with inflation. In order to tackle the inflation problem, this mechanism was removed from a large number of collective agreements.
There are no signs that a wage-price spiral is imminent at the moment. However, employees in various sectors are able to enforce higher wages, under pressure from inflation and large staff shortages. For example, after several strikes, the trade unions agreed with the NS that railway staff will improve by 9.25 percent in the coming year and a half. They were unable to pull off an automatic price compensation. Incidentally, this mechanism does not automatically result in a wage-price spiral: in Belgium, for example, the apc is still standard.
Can’t the government just fix prices?
In theory yes. The problem is that simply fixing prices does not remove the causes of inflation, such as the gas shortage in Europe. US President Nixon locked all prices (and wages) for 90 days in 1971 as part of his inflation stance, but they skyrocketed afterwards.
The Dutch cabinet wants to fix energy prices for households from 1 January until the point where they exceed the average consumption. This does not combat inflation, only the consequences: the government pays back the difference to the energy companies, who, after all, still pay the full price when purchasing energy.
Central banks, such as the European Central Bank (ECB), can try to contain inflation by raising interest rates. This makes it more expensive for banks to borrow money, a price they pass on by charging more interest on corporate loans or mortgages. The intended effect is ‘cooling off’ of the economy: companies and consumers borrow less and spend less, so that supply and demand must be better balanced.
The ECB decided this year to raise interest rates for the first time in 11 years, because inflation had gotten too far out of control. A second rate hike in September, at 0.75 percentage point, was even the biggest step since the introduction of the euro. This was probably not the last rate hike, ECB President Christine Lagarde already announced.
How long will high inflation last?
At least another year and a half, the ECB thinks. The central bank assumes 8.1 percent inflation for the euro zone this year, 5.5 percent next year and 2.3 percent in 2024. The latter percentage is only close to the situation that the ECB would like to see. By then, some prices may have fallen again—think energy bills, if sufficient alternatives to Russian gas are found—but the central banks are not trading on a general fall in prices. No one knows for sure what will happen: inflation is notoriously difficult to predict.