House prices are skyrocketing, groceries are becoming more expensive and every refueling hurts the wallet a little more. Is the high inflation temporary or will these price increases continue in the coming years? Many economists have been pondering that question since inflation shot through the roof late last year.

The European Central Bank (ECB) has always reassured that inflation would soon return to normal, because the high price increases are a temporary consequence of an economy recovering from corona. But eighteen months after the start of the corona crisis, inflation is at 3.4 percent, according to CBS, the highest level since 2002.

Nevertheless, the current high inflation is probably temporary, concludes De Nederlandsche Bank (DNB) in a new analysis. According to DNB, the high inflation can be explained by a number of temporary factors, some of which will disappear in the coming months. For example, the so-called base effect: prices were relatively low last year, and the correction alone contributes to inflation.

Another part of the factors is also temporary, but seems to last longer than originally thought. That applies to rising energy prices, supply problems and increased demand for products as people postponed purchases during the pandemic.

“For eight years we held a kind of futile rain dance for some more inflation, now the corona shock suddenly leads to more inflation,” DNB president Klaas Knot said in Nieuwsuur. “The interesting question is: the factors that lead to temporarily higher inflation, how temporary are they? If they last longer than we think, we as central bankers will have to react.”

Wage-price spiral

It is possible that companies and households will adjust their behavior to the high inflation, DNB writes. If that happens, so-called second round effects can arise, which means that inflation can remain high for a longer period of time.

For example, unions can demand higher wages, after which employers pass on those higher wages in the prices. Those higher prices can, in turn, lead workers to want higher wages again, creating a wage-price spiral that drives inflation up.

DNB does not yet see any signs of such a wage-price spiral, but it does warn against it. For example, it is possible that companies that are still reluctant to raise wages due to uncertainty about the corona pandemic will do so later, DNB writes.

It is striking that DNB has chosen to include this warning in its analysis, says economist Mathijs Bouman. “There is also a strategic importance behind this. DNB President Klaas Knot is opposed to the stimulus measures that the ECB has been taking for years to maintain inflation in the eurozone. If the high inflation is less temporary than originally thought, then those measures may indeed be partly superfluous.”

If inflation does indeed reach a long-term high level via a wage price spiral, a situation arises in which money quickly loses value. “Then you get a lot of unwanted redistribution,” says Bouman. “For example, some people are in a position where they can easily ask for a higher wage, others are not. But the most important thing is that people no longer dare to take financial risks, because of the uncertainty about the value of their money.”

Positive effect

But if inflation really gets out of hand, the ECB will always take measures, says Bouman. This can be done, for example, by raising interest rates. “In addition, the longer you wait, the more painful the measures ultimately cause.”

Incidentally, a short period of high inflation can also have a positive effect on the economy, DNB writes. Since inflation has long been below 2%, a temporary high inflation rate could “anchor” inflation expectations among citizens and businesses around that ECB target. “And expectation is often the main driving force behind inflation levels,” says Bouman.

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