The way to tackle inflation

Tackling inflation at a Cypriot and European level requires an immediate and drastic increase in interest rates and targeted fiscal measures that will not worsen it, Marios Zachariadis, Professor of Economics at the University of Cyprus told CNA on Tuesday.

One thing we can do, he said replying to CNA questions on the matter, is to avoid expansionary policies, like an increase in government expenditure, tax cuts so large that they affect demand and therefore inflation. "Certainly, the vulnerable groups, the poorer, must be protected," he noted. In their case, he said, "I believe, targeted measures should be taken, similar to some of those announced. Because their income is so low that they can not reduce demand and consumption further."

At the same time, the rest of us should reduce our consumption as much as we can. It comes down to the individual level, how everyone will manage the crisis, Dr. Zachariadis pointed out.

"It is not just a fiscal problem to take horizontal measures, which increase government spending or reduce taxes, which could lead to higher inflation in one euro-zone country than another, reducing its competitiveness and leading to a recession," he said.

According to the University of Cyprus professor "horizontal policies could hurt and should be avoided, while targeted measures are taken to maintain some purchasing power of those most in need."

Dr. Zachariadis stressed that raising interest rates at Eurozone level is a necessary part of the solution to tackle inflation, for two reasons. When interest rates rise, demand pushes down. They need to be increased fast and high enough to hold extra demand down, he said. The second reason, he added, which is not often mentioned, is to contain a drop of the euro against the dollar. The euro has weakened by 15% in the last year, he noted. In the last month it has recovered and is 12% lower against the dollar.

"To have a devaluation of the euro, because interest rates are lower and are expected to stay lower, with their correction being slower than the US interest rate correction, implies a devaluation of the currency, which fuels inflation. For example, oil is priced in dollars. If the euro depreciates against the dollar, oil becomes even more expensive," he pointed out.

Replying to a question whether the increase in interest rates is here to stay or is a temporary phenomenon to deal with inflationary trends, Dr. Zachariadis replied that the exception was the recent years when there were negative interest rates, a rare phenomenon that has always had a temporary form. Positive interest rates, or even higher than we have historically had, will be needed to contain inflation.

If inflation is not controlled immediately, then it is integrated into what consumers and businesses expect, resulting in it becoming a permanent or persistent phenomenon. Therefore the increase in interest rates is expected to be long-term and the longer it is delayed the greater will be the need for very high interest rates.

In the medium term, market surveillance institutions need to be strengthened, dr Zachariadis said. In addition to strengthening the relevant legislation, there should be proper staffing, with people who know the subject in depth and can analyze data, so that they can detect lack of competition or cartel phenomena, suggested Dr. Zachariadis.

Cyprus is at a better level than the European average, he noted, in terms of how flexible the economy is and how quickly prices change, even downwards. However, he warned, there are no deterrents to agreed price increases and profiteering, and this needs to be rectified.

Studying inflation historically, two phenomena appear, he said. The first is that there are opportunistic price increases, even from companies that did not have cost increases. This is a very basic reason for price increases, he noted, and many of the price increases we see are due to opportunistic strategic business pricing.

The second phenomenon is that there is a large dispersion of prices, when inflation is high. If we compare different supermarkets or gas stations, there are very big differences in prices. Therefore, it is important for everyone to be careful about what and where they shop, he concluded.