It’s a truism: Rising prices mean people’s purchasing power falls. Consequently, consumers can afford less. This buffers consumption. And if consumption is taxed, then companies can sell less. So the result is clear: current price increases are bad for the global economy. Of course, there are the oil and gas exporting countries that are now earning more, investing this extra income in luxury goods, war material or magnificent buildings, and are therefore asking for a little more than usual. But the world market shares of these countries are too low to reverse the generally negative trend.
The price increases now come at a time when the global economy is already groaning under high rates of inflation. In the US, this has just hit the eight percent mark. Soaring prices for oil, gas, raw materials, food, and processed goods mean nothing more than a supply shock hitting the global economy. You may remember the simple graph we used in episode II to show the situation in the US. Extremely accommodative monetary policy and strong fiscal stimulus have boosted demand, while tight supply and rising commodity prices raw materials have caused a shock in supply. The result is higher prices (P2>P1) with continued good utilization of production capacities (M1 approximately M2).
The war in Ukraine triggered a second supply shock in a short space of time, even before the first had subsided: supply bottlenecks and rising commodity and energy prices made output more expensive. The economy can only produce the same amount of goods and services at a higher price, so the supply curve shifts up. But higher prices reduce consumption: In our simplified model, prices continue to rise from P2 to P3, where new supply and demand meet. Consequently, the quantity produced and sold in our simple world decreases from M2 to M3.
How strong the price increases will be will be decided in the coming weeks. If prices rise and production stagnates, this is called stagnation. If output even fell (as in the chart), we would have a perfect recession with high inflation rates.
What does that mean for Switzerland? As a very open economy with few raw materials of our own, we are drawn directly into the aftermath of the Ukraine war. Swiss producers are also experiencing supply chain disruptions and price increases for primary products. Consequently, they can produce less or only at higher prices. Of less importance is the drop in exports to Russia and Ukraine, whose share in Swiss exports is small, at 1 percent and 0.2 percent, respectively. But the loss of purchasing power around the world means that the demand for Swiss products and services is falling. The situation is made more difficult because Swiss exports are becoming more expensive relative to the competition due to the strength of the Swiss franc abroad. Conversely, the strength of the Swiss franc is also dampening the rise in prices of imported goods, so rising inflation in Switzerland is less severe than abroad. Consequently, Swiss consumption will also be less affected.
If the armed conflict does not escalate, which could result in a severe recession in Europe, the overall impact on the Swiss economy should not be dramatic. Especially not in the context of the immense suffering of the Ukrainian population.
FOCUS ON INFLATION
Episode I: Beware the money illusion: the Swiss franc is no longer as strong as it was in 2015
Episode II: Four Reasons for the Record Rate of Inflation in the US
Episode III: “This time is different”, really?
Episode IV: Not Neutral, but Pretty Nasty
Episode V: The Independent SNB Strikes Back
Episode VI: Why doesn’t rising oil prices have a stronger impact on Switzerland?
Episode VII: The Ukraine War Fuels Inflation