Contributors
Shamir Shoukat Ali 20191-25601
Zarmeen Bhaidani 20202-26908
Muhammad Mustafa 20202-26827
Affiliations :MBA Student of Institute of Business Management
Impact of the pandemic on inflation
The impact of the pandemic on inflation could by deflation, disinflation, or higher inflation. Therefore, it is important to determine by assessing the demand-side and supply-side shocks.
Demand shocks
Demand-side shocks intimate the aggregate demand of the economy. An increase in aggregate demand leads to higher inflation and vice versa. Aggregate demand is a function of consumption, investment, government expenditure, and net imports (Del Negro, et al., 2020). Due to the Covid-19 pandemic, there has been a reduction of work opportunities, and most of the businesses were temporarily closed. This led to an increase in unemployment, and ultimately consumers faced the loss of income. As a consumer’s income became uncertain, their purchasing power fell. Hence, the total consumption of the fell, which ultimately leads to a decrease in aggregate demand. In addition, the investments also declined, as investor’s loss of confidence in the market due to falling demand (Armantier, et al., 2020). A reduction in the aggregate demand has led to economic slowdown due to demand contraction leading to deflationary pressure as shown in the graph below.
Moreover, an important aspect of Covid-19 pandemic is the change in consumer spending patterns. Consumers are now spending more on necessary products such as fast-moving consumer goods rather than travel, clothing, and accessories. Therefore, demand for a particular sector increased dramatically that lead to an increase in inflation.
Supply shocks
Inflation in an economy is determined where the aggregate demand and aggregate supply of the economy intersect also known as the equilibrium point. While aggregate demand shocks have been discussed, now supply shocks would be discussed caused by the pandemic. Due to the pandemic, the production of many companies was halted due to the imposition of locked down. The supply chain of several companies was effected. Moreover, companies could not efficiently utilize the labor workforce because of social distancing. Hence, all of these factors increased the cost of production of most companies that caused an upward pressure in aggregate supply (Banerjee, et al., 2020).
On the other hand, the costs of fuel and energy declined globally that caused a downward pressure in the aggregate supply because of the reduced cost of production for several companies.
In addition, retailers to maintain their sales were also forced to reduce their prices in order to remain more competitive. Therefore, for the food industry, the prices surged as the cost of production increased, and the demand also increased drastically. While for other industries the cost of production reduced due to low energy, and fuel cost (Balleer, et al., 2020). In some categories such as electronic equipment, the prices increased due to a shortage of goods as production and distribution reduced.
All in all, the slowdown of the economy due to falling aggregate demand offsets the increase in the cost of production (supply). Hence, the impact of the Covid-19 pandemic on inflation is that it caused disinflation. Since the prices of several goods and services increased, it is least likely that their wold is deflation. It can also be observed in the graph below that inflation continued to fell from Jan-20 to April-20 mainly due to economic slowdown.
Similarly, disinflation due to pandemic is also evident in the graph above which shows the inflation rate of the US. It can be seen that the inflation rate fell from 2.49% in Jan 2020 to 0.65% in May 2020.
Impact of inflation on pandemic
To assess the impact of inflation on the pandemic, it is important to understand the state of inflation as a pandemic advance. As discussed above, the immediate impact of the pandemic is disinflation. However, as pandemic advances, inflation is most likely to surge. This is because of the particular characteristic of pandemic known as social distancing. Due to maintaining social distancing, the cost of production for most of the businesses would go high. Restaurants would be able to entertain fewer consumers, airlines would carry fewer passengers, additional costs would incur due to disinfection, and supply chain changes would also carry additional costs. In addition, firms that survive in the crisis would have a high price authority (Coibion, et al., 2020). Hence, social distancing would ultimately increase the cost of production leading to even higher inflation as aggregate supply will reduce. Since this would have cost-push inflation, unemployment would further rise, as companies would not be able to afford employees. Hence, this will have a positive effect on the pandemic in the sense that more and more people would exercise locked down. This will improve the situation as the spread of the virus would be contained and people will recover quickly. Therefore, cost-push inflation is likely to better in containing the virus and hence would have a positive impact on the pandemic.
On the other hand, if inflation is caused by demand-pull it would have a negative impact on the pandemic. As demand-pull inflation is caused by an increase in aggregate demand, it would imply that the economy is going up, more production is taking place, more people would be employed, and there would be more economic activity (Del Negro, et al., 2020). If economic activity increases, there is a very high chance that the virus would spread at a faster pace. Moreover, higher economic activity would also imply that there are fewer people on locked down, and more on work. Therefore, this would reduce the recovery rate as well. Hence, demand-pull inflation would cause a negative impact on the pandemic.
Conclusion
It is concluded that the pandemic would most likely cause disinflation. The main reason discussed is the reduction of aggregate demand due to uncertainty and unemployment. Industries that use energy and fuel as raw materials are likely to face a lower cost of production, while industries such as food and clothing are likely to face a higher cost of production. It is inferred that lower aggregate demand would overwhelm the supply shocks, and ultimately lead to disinflation. It is also observed that CPI in Pakistan and the US declined rapidly as Covid-19 was declared as a global pandemic. In addition, it is concluded that the impact on pandemic on inflation would depend on the type of inflation. If inflation is caused by cost-push factors, there is going to be a positive impact on the pandemic. On the other hand, if inflation is caused by demand-pull factors, the pandemic would go even worse.
References
Armantier, O., Koşar, G., Pomerantz, R., Skandalis, D., Smith, K., Topa, G. and Van der Klaauw, W., 2020. Inflation Expectations in Times of COVID-19 (No. 20200513). Federal Reserve Bank of New York.
Balleer, A., Link, S., Menkhoff, M. and Zorn, P., 2020. Demand or Supply? Price Adjustment during the Covid-19 Pandemic.
Banerjee, R.N., Mehrotra, A. and Zampolli, F., 2020. Inflation at risk from Covid-19 (No. 28). Bank for International Settlements.
Coibion, O., Gorodnichenko, Y. and Weber, M., 2020. The cost of the covid-19 crisis: Lockdowns, macroeconomic expectations, and consumer spending (No. w27141). National Bureau of Economic Research.
Del Negro, M., Lenza, M., Primiceri, G.E. and Tambalotti, A., 2020. What’s up with Inflation and the Business Cycle after the COVID-19 Shock?. Mimeo, Northwestern University.
Iqbal, S., 2020. Pakistan Saw Highest Inflation In The World During 2020: SBP. [online] DAWN.COM. Available at: <https://www.dawn.com/news/1561860> [Accessed 11 August 2020].
McMahon, T., 2020. October Inflation Has Slight Increase. [online] InflationData.com. Available at: <https://inflationdata.com/articles/2019/11/14/october-inflation-has-slight-increase/> [Accessed 11 August 2020].
