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Inflation is a tax without legislation”.

― Milton Friedman

Inflation has been high and sticky for longer than expected, and analysis of the composition of inflation indices suggests that price pressures are broad-based.

Therefore, any package of measures to face it must contain measures that act on expectations.

The danger of a high level of inflation in the world, (4% per year or higher for several years) is greater in the United States.

Strong monetary growth will help keep inflation high this year and add to long-term inflation risks. The evolution of the labor market could also generate inflationary pressures, although there are considerable differences between countries, an example of this is the low wage growth in the eurozone.

Long-term inflation expectations have increased, although they have not exceeded their ranges for the last 20 years. In the United States, the bias is toward higher inflation.

More than half of the consumer basket in the United States is increasing at a rate of 5% or more.

The supply shocks continue, the problems in the supply chains have not disappeared and may be accentuated by the wave of Omicron (for example, with the closure of Chinese ports). Europe is being affected by the sharp rise in energy prices, (with gas prices tripling since last June). High inflation has increased the risks of a more permanent change in the inflationary process.

In December, consumer prices in the United States reached a forty-year high, and core inflation in advanced economies has moved to its highest level since the early 1990s. Inflation forecasts for 2022, have increased considerably since last June.

Monetary growth remains a risk to inflation. Although money supply growth slowed last year, from its high levels in 2020. Still, the considerable monetary “overhead” from the increase in money growth during 2020 remains, and its pace of growth remains relatively strong. Given that money growth has led inflation, we expect inflation to remain above target for some time.

In the US and Canada, six-month annualized money growth is over 10%, roughly double its pre-Covid pace.

In Europe, money growth is also elevated compared to its 2016-2019 pace, and it looks much more normal in Asia, where inflation is still under control, South Korea being the exception. Which shows that inflation in advanced economies is not only the result of global factors.

Developments in the labor market constitute another upside risk to inflation, at least in some economies. In the United States, rising attrition rates and rising wages point to a considerable tightness in the labor market. Vacancies and resignations data go in the same direction in the UK.

Although long-term inflation expectations are contained, we believe that the inflationary process will exceed its objective in advanced economies for 6-8 quarters in 2020-2022.

The risk is that such a significant divergence from the target begins to de-anchor long-term inflation expectations, entrenching inflation.

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