The latest IMF report highlights the recessive effects generated by the invasion of Ukraine on the world economy, as well as a series of supply shocks that mark a new global inflationary era.
If the inflation that triggered the pandemic was considered transitory, the inflationary pressure that is now detected shows a structural character. The global economy enters a new stage of higher inflation.
For some experts, this represents déjà vu of the 1970s oil crisis that transformed the economy and international finance. The crisis marked the decline of post-war Keynesianism and monetarism emerged as the dominant view.
At the same time, an interest in ecological issues and the environment was also growing, and sustainable development began to be considered. Shortly thereafter, the scientific community began to raise awareness of the problem of global warming.
Rethinking the inflationary dilemma facing the challenge of climate change
In low- and middle-income countries, external shocks acquire an outstanding relevance, as well as a more pronounced frequency.
Within this framework, commodity-exporting countries (oil, mining, agriculture) benefit from higher prices, although they are exposed to higher inflation. These are countries with little diversified economies and strong social inequality, so inflation ends up affecting the majority, given their consumption patterns.
On the other hand, climatic phenomena become extreme and emerge with increasing force, which poses great challenges in the economic sphere.
In this framework, the monetary authorities should monitor the risks, since a transition without objectives can imply the problem of irrecoverable assets. But neither should they neglect the effects that such a transition generates on the inflationary phenomenon.
The macroeconomic imbalances associated with extreme events require large investments in adaptation, which leads to a resurgence of inflation.
With investments in mitigation, we observed that the transition process triggered a significant increase in the price of minerals such as copper, nickel, graphite, lithium or cobalt. An electric car consumes six times more minerals than an internal combustion car, and minerals account for 20% of the cost of wind power equipment.
All this has led to significant increases in the price of these minerals in the last two years. The price of lithium has increased by 1000%, that of nickel by 300% and that of copper by 200%
These new energy equipment do not generate more than 3% of the total energy produced, while electric cars do not represent more than 1% of the world fleet. While the transition may prove to be a blessing due to higher revenues, it can easily turn into a curse with strong inflationary consequences.
Clean production also implies higher costs that should not be seen as a luxury in developed countries.
In fact, the implementation by the EU of the carbon tax at the border requires that we consider the environment when planning development, as it implies investments that will also generate more inflation.
In order to move forward with clean energy and move beyond dependence on fossil fuels, several policy options emerge: carbon pricing, regulation, subsidies. Whatever the alternative, they all imply a higher cost that affects companies and consumers.
In the case of the value of EU emission allowances, while a ton of carbon was around 21 euros in February 2021, the following year it was close to 100 euros. But beyond the variations, the path is explained by the decisions adopted both in recent years and by the invasion of Ukraine.
The imposition of a carbon tax (the elimination of subsidies to fossil fuels) implies not only greater inflationary pressure, but also greater social tension, given the transfer (total or partial) of the increment to consumers.
Even if its introduction leads to less contamination, the tax is regressive since it is the poorest social sectors that allocate a greater proportion of their income to the purchase of fuel or public transport.
Despite this, it appears that futures markets have embraced the transition as irreversible. Financing for oil companies has become more expensive, either because of the fear of irrecoverable assets or the emergence of stricter regulations.
All this induced a lower investment rate, which in the current situation strengthens fuel prices and generates greater inflationary pressure. This should speed up the transition. However, it cannot be ignored that such a process requires time, since the investments are expensive. One way or another, the transition generates inflationary effects.
This suggests that the traditional monetary policy response of tightening credit conditions is not the best option. Such a response is more appropriate in countries where the financial sector is scarcely relevant. But if aggregate demand in these countries is insensitive to changes in interest rates, the reaction to the exchange rate is different.
An increase in commodity prices leads to an appreciation of the national currency, a phenomenon that can be amplified by the inflow of financial capital in the face of an increase in the local interest rate (carry trade).
Although this benefits consumption and, eventually, the poorest sectors, the bonanza has destructive effects on the productive apparatus, especially in economies open to capital flows. This explains the unorthodox responses implemented by several governments in the region in the 2000s, as well as the Fund’s change of heart on capital controls recently ratified.
In addition to the situation, marked by the Russian invasion, the energy transition characterizes the current inflationary phenomenon as long-lasting and the region should move forward with the transition. This forces the political class to think about alternatives and come up with innovative proposals.
For example, an extraordinary income tax could be introduced to tax the profits of mining companies, as they will continue to rise during the transition. One could also move forward with some variant of the capital control scheme used in the past by Chile, but now penalizing the funds that enter to finance polluting industries.
When evaluating the problem, we must leave the dogmas behind and act pragmatically. We have to move towards a new production and consumption scheme in which the transition results in a sequential process. And governments should intervene to mitigate the macroeconomic consequences (price stability, exchange rate competitiveness, social policy and just transition) as well as to prevent the generation of financial bubbles (investment in assets that may become unrecoverable).
Spanish translation by Giulia Gaspar
