How Economies are Reacting to Global Inflation

The Russian Invasion of Ukraine

Before we dive deeper into how inflation is affecting specific territories, let’s address the elephant in the room. Russia invaded Ukraine in February, and the most serious effect of this conflict is higher commodity prices worldwide. Behind the US and Saudi Arabia, Russia is the third-biggest oil-producing country in the world, and the sanctions imposed on Russian commodities have caused oil prices worldwide to soar. Experts expect oil prices to hover around 110$ per barrel this year and remain volatile due to the low supply caused by the sanctions on Russian oil. As economies recover from the pandemic and demand increases, oil-producing countries will not be able to ramp up production without increased investment. The UAE’s energy minister warned that oil prices are nowhere near their peak and are still expected to soar considering the strenuous global situation. So how is all this playing out across the globe?

The United States

Despite the rise of China, the USA is still the largest economy in the world, and it is witnessing a record increase in inflation rates. According to the US Census Bureau, inflation is at a 40-year high, reaching 8.6%. With the prices of food increasing, a quarter of Americans are now reported to be below the poverty line, and 11% of the lower middle class cannot even afford to buy food. You might think this is the consequence of the pandemic, but as counterintuitive as it may seem, Covid actually made Americans richer. During the lockdown, the US government issued generous stimulus packages and provided months of unemployment benefits to compensate for the loss of jobs. This resulted in increased savings, and when Covid measures started loosening up, Americans did what they do best: consume. Unfortunately, a slow-to-recover supply chain could not keep up with the surge in demand, so prices went up. It’s simple economics, when the high demand and the supply is low, prices are bound to go up. The increased cost of doing business is another reason why prices are rising. More expensive raw materials and labor have increased the cost of production, which corporations are passing directly to the consumer, contributing to inflation. To counter the effects of inflation, the Federal Reserve is considering increasing interest rates by 3 times. Higher interest rates make borrowing more expensive and give people more incentive to save their money. This can ultimately reduce demand and push prices down. But needless to say, reduced demand for goods and services can stunt economic growth, and lead to recessions.

Europe

The story of inflation in Europe is quite the opposite. Unlike Americans, Europeans do not have the tendency to spend money. When the pandemic hit in 2020, inflation in Europe went down, and by December 2020 it actually reached a negative value of 0.3% according to EUROSTAT. When lockdowns were put into place, people stayed home, and businesses shut down. This reduced demand and ultimately prices. Now, however, the inflation in Europe is at 8.1% and it’s mainly attributed to the cost of energy. Energy costs are very sensitive. Weather patterns, low inventories of oil and gas, lack of investment, and bottlenecks in renewable energy sources can all contribute to a spike in energy costs. Europe’s reliance on Russian natural gas has also exasperated the issue and is causing supply cuts across the continent. With all things considered, energy prices are expected to soar by over 50% this year according to the Bank of America. Things are not looking good if you’re the European Central Bank right now, however, considering the Covid-induced stimulus packages were smaller than the US, demand-driven inflation should also not be as severe as in the States.

China

China’s annual inflation rate was at 2.1% in May 2022 according to the National Bureau of Statistics of China. Increased demand due to easing of Covid measures could lead to increased prices later this year, however, the rate is not nearly as alarming as in the US and Europe. While this can be attributed to Beijing being cautious about handing out stimulus packages that ultimately increase spending, some of the reason is also due to the weighting of goods and services. China gives more weight to clothes and food, while the US places more emphasis on shelter and transport which are more influenced by fluctuating oil prices and domestic monetary conditions. Another major reason is China’s massive industrial arm. China is the largest exporting country in the world, and unlike the US, it does not heavily rely on the import of consumer goods. This gives Beijing more room to deal with price hikes for global commodities. So while prices have been increasing all over the world, China has more or less kept inflation at bay and remains an economic powerhouse in times of global struggle.

GCC and other Arab countries

While the Gulf Council States and the wider Middle East saw a rise in inflation, its effects were not as dramatic as in the US or Europe. The Russian invasion of Ukraine did increase commodity prices, with the cost of fuel increasing by over 56% since the beginning of the year in the UAE. However, the consumer price index is expected to only reach 4.3%, a rise from 2.3% the previous year. The remaining council states will also witness a surge in inflation varying between 2.5% to 3.5% due to heightened demand and the impact of the pandemic on the international supply chain. While the cost of living is increasing in the GCC, the rate of increase is still slower than in other regions, which does not warrant any increase in interest rates at the moment. in Arab countries in general, the inflation rate is supposed to rise to 7.5% compared to 5.7% in the previous year.

The Long Run

Just when we closed the door on the pandemic and began to revive the global economy, the Russian invasion of Ukraine plunged us again into an economic abyss mainly centered around the overly sensitive energy sector. While governments can reduce the incentive to spend by increasing interest rates, there is nothing that can be done about the war and its effects on oil prices in the short run. What we can do in the long run, however, is increase our investments in renewable energy sources so economies are not held hostage by volatile political situations that more often than not fluctuate an overly sensitive commodity market.

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