IMF warns of endless inflation effects amid consequent wage rise

The lender notes that when inflation is high, wages tend to rise more in response.

In Summary
  • A wage growth response could mean inflation rising over an extended period occasioning second round effects.
  • When the effects grow further,the risk of a sustained wage-price spiral through a feedback loop between wages and prices would become greater.
IMF headquarters
IMF headquarters

Consumers in the near future could face a sustained increase in inflation if wage increase is used as a response to tame the global crisis.

With the recent hike in fuel prices on the back of inflation, consumers would further have to deal with the challenge of taming increased costs of basic commodities, the second round effects.

Prices for all the products on store shelves could soon spike gauging the seep into the cost of living and wages of consumers.

Filling the gas tank would also start to cost even more so will airfare and roadfare.

Already there have been moves by various matatu owners who have announced fare hikes in what could worsen operations in the transport sector.

IMF in its economic outlook notes that when inflation is high, wages tend to rise more in response to a spike in oil prices for instance. It terms the initiative as risky.

“The more wages rise, the greater the risk of a sustained increase in inflation and if this kind of feedback is large and sustained, a wage-price spiral could emerge. Wage growth could mean inflation rising over an extended period,” IMF says.

The country’s inflation climbed to a five-year high in August on soaring food and fuel prices as well as the cost of home equipment and appliances.

According to the monthly inflation data by the Kenya National Bureau of Statistics (KNBS)released last month, a measure of the cost of living over the last 12 months rose by 20 basis points to 8.5 per cent up from 8.3 per cent in July. 

This was largely driven by the average cost of food and non-alcoholic drinks which climbed 15.3 per cent.

Housing, Water, Electricity, Gas and Other Fuels Index also increased by 5.6 per cent in the last 12 months.

This marked the third month in a row the year-on-year cost of living measure crossed the upper limit target of 7.5 per cent.

The inflation rate in August was the highest since June 2017 when it hit 9.21 percent. It already has adverse effects on the cost of living.

When the second-round effects grow further,the risk of a sustained wage-price spiral through a feedback loop between wages and prices would become greater.

In turn, the large and sustained oil price shocks for instance could fuel persistent rises in inflation and its expectations.

The global lender hence advocates for monetary policy response to counter the inflation concerns.

It further urges central banks to respond firmly on concerns of how the current high inflation could increase the risk of energy prices causing sizable second-round effects and a sustained increase in inflation, which includes pushing up inflation expectations.

Backed on the research by the lender which revealed that when overall inflation is already high, wages normally tend to increase, a reflection could be made that people are more likely to react to price increases when high inflation is visibly eroding living standards.

“When overall inflation is higher, people tend to be more alert to price increases of all stripes and seek higher compensation. However, differences between high and low inflation periods could impart two messages on the current situation, one concerning and the other reassuring,” IMF says.

What could be reassuring is that even in a high inflation environment, wages should be stabilised rather than continuing to rise at a steady clip.

“There should be a wage level amidst the inflation crisis instead of frequent wage inflation increase,” IMF reiterates.

Inflation is a global phenomenon, with leading economies like the US, UK and several countries in Western Europe reporting a 40-year high. 

As of August, the US Federal Bank was expected to raise the base lending rate by between 0.75 and 1.5 an approach to slow inflation. 

Apex banks globally use the interest rates as either a gas pedal or a brake on the economy when needed.

They set the short-term borrowing rate for commercial banks, and the banks pass it along to consumers and businesses.

With inflation running high, they can raise interest rates and use that to pump the brakes on the economy in an effort to get inflation under control.

In May, CBK raised the base lending rate by 50 basis points to 7.5 per cent as a measure to contain the rising cost of living.

Continued short-term measures in curbing inflation for instance demanding wage increases would mean further tightening of base lending rate by apex banks.

This would trickle down to the consumers who will have to go deeper in their pockets to acquire basic commodities whose prices will have hiked.

To such an extent, central banks are urged to remain adequately vigilant as the current high inflation could still cause higher compensation for the cost of living than usual.

The global lender however cautions them not to morph into a sustained increase in inflation.

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