Central Europe’s Flourishing Economy Dulled by Inflation

Central Europe is at the epicenter of Europe’s rising inflationary pressures. In May, Poland’s inflation rate reached 4.7 percent, before dropping to 4.4 percent in June. With a rate of 5.1%, Hungary has the highest inflation rate in the EU. Some of this is due to temporary circumstances.

Some of this is due to temporary circumstances. However, there are reasons to believe that pricing pressures in these two countries will persist, perhaps causing tensions between their central banks and their free-spending nationalist governments.

It also runs the danger of tarnishing their carefully built reputations for macroeconomic orthodoxy. Budapest and Warsaw have been shielded from closer scrutiny of their domestic agendas of restricting media freedom, curtailing minority rights, and politicizing the judiciary by Brussels and Berlin’s praise for their economic management, which has made them a preferred destination for German investment.

Over the longer run, inflation in Poland and Hungary is well above the respective midpoint targets of 2.5 and 3% set by the two central banks. However, Poland’s central bank governor, Adam Glapinski, is not in a hurry to boost interest rates. Inflation in Poland, according to Glapinski, is “not a cause for concern.” According to him, supply-side and regulatory reasons were mostly to blame for the increase.

Last month, Hungary’s central bank governor, Gyorgy Matolcsy, called on the government to sharply tighten fiscal policy, aiming to reduce the deficit from 7.5 percent of GDP this year to 3 percent next year. He called the government’s fiscal plans a “mistake.”

Prime Minister Viktor Orban has refused Matolcsy, who has dangled the idea of a sizable income tax cut for families with children (like to Warsaw’s “Polish bargain”) just in time for next year’s parliamentary election, which is shaping up to be a tight battle.

Orban also appeared to throw a shot across the governor’s bows, saying he wished for “cautious and measured” interest rate hikes. Following that, the central bank hiked its main policy rate by 30 basis points to 0.9 percent, the first increase in a decade. It also stated that it would continue to tighten monthly.

Before the latest pressures linked to the end of the pandemic, central European economies were experiencing “stubbornly high inflation,” and “the risks over the coming years are skewed to a prolonged period of much higher inflation and, subsequently, more aggressive monetary tightening,” according to the report.

The multilateral lender, the European Bank for Reconstruction and Development, has expressed its concern as well. There were short-term variables, such as pent-up demand after the end of the pandemic, but there were also longer-term ones, according to Beata Javorcik, chief economist.

The first is the region’s sweltering labor market, which is compounded by the region’s low demographics. Despite the economic downturn, average incomes in Hungary and Poland increased by 10.6% and 7.8%, respectively, last year. Poland has a low unemployment rate of 3.1%. It may be able to rely on migrant labor from Ukraine, but Hungary’s anti-immigration government is less likely to do so.

Second, money from the EU recovery fund will begin flowing later this summer and will continue for the next four years, boosting demand even more – as will income tax cuts from both governments.

Third, in economies that are still largely reliant on fossil fuels, decarbonization will raise producer prices. Finally, unlike western Europeans, older Hungarians and Poles remember hyperinflation at the collapse of communism, which means their pricing expectations may move more swiftly, posing a problem for central banks with a recent experience of independence.

The return of inflation in advanced economies may turn out to be more of a phantom than a threat, but it is a real threat in central Europe, thanks to demography. The region is fast recovering from the pandemic, aided by increased trade. Inflation and salary growth rise in tandem with economic convergence with wealthier neighbors.

However, rising prices are already eroding many people’s living circumstances. There may be danger coming unless central banks respond decisively.

Photo Credit: https://cadenaser.com/emisora/2018/07/17/radio_cadiz/1531818272_306536.html