Commodity prices, and consequently energy prices, are one of the components of inflation, and their impact is now much higher than in recent decades. In contrast, high inflation should drive down commodity prices in the future – says Maciej Bukowski, Program Director at the WiseEuropa think tank, in an interview with BiznesAlert.pl.
BiznesAlert.pl: How does the energy crisis affect inflation?
Maciej Bukowski: For countries with a high level of inflation, it is important to understand its structure, including the separation of temporary factors related to the supply-side (the impact of Russian aggression in Ukraine on the energy and food markets), from fundamental factors of a long-term nature (tight labor market, large borrowing needs of the public sector). In Poland, the latter account for approx. 65-70 percent, which is one of the highest results in the EU countries, including the V4 and the Baltics. Such a structure may make it more difficult to reduce inflation in Poland and may be more costly for many sectors of the economy than in other countries in the region. Energy prices are rising, fuelling inflation more and more (today it is approx. 20 percent), for several reasons. Firstly, because the effects of the shocks in the fuel markets are beginning to spill over to other kinds of energy, and secondly, because a progressively larger group of consumers are having to face higher energy costs, e.g. as a result of the expiry of fixed-price contracts or changes in regulated prices. However, this situation will not last indefinitely. The current situation is caused by insufficient supply of raw materials (both from Russian and other producers), and combined with a strong rebound in demand after the coronavirus. Over time, however, new production capacities and new supply routes for gas, coal and oil will emerge and the situation will stabilize. This is because high prices encourage increasing production at the cost of competition, which is being sanctioned. Therefore, the decisions made by producers as well as political decisions on Iran and Venezuela, among others, will have the final word.
What is the relationship between inflation and high energy and commodity prices?
Commodity prices, and consequently energy prices, are one of the components of inflation, and their impact on it is now much higher than in recent decades. In contrast, high inflation should drive down commodity prices in the future (risk of higher interest rates, investment uncertainty, more expensive credit, less investment from other areas of the economy, slowing demand). Commodity prices are strongly correlated with economic conditions-in times of economic recovery and increased demand, their price rises, but during an economic downturn their price drops.
Today we are faced with an exceptional situation, because EU countries are trying very quickly to become independent of raw materials from Russia, which causes serious disturbances in the world’s raw materials markets – because there is a growing demand for raw materials from other directions, which cannot be filled quickly – for technical and contractual reasons. The same applies to Russia itself, which is trying to find new buyers-so we have a „big reshuffle” on the global oil, gas, coal markets, which is projected on the prices of these raw materials.
Which tools from the energy sector can ease the price surge on the energy and commodity markets?
First, changes in the structure of the energy mix – the structure of energy production, especially renewables and nuclear power. Secondly, reducing demand, which entails replacing heating sources to ones that are more efficient or don’t require fuel at all, as well as upgrading the insulation of buildings. Third, infrastructural investments in transmission, storage and availability that increase supply diversification. Fourth, lowering the needs when it comes to transport (less travel, more public transport, slower driving, etc.), or heating (lowering temperatures in rooms).
What is your forecast for the energy market this heating season?
It will be crucial to ensure the right amount of supply. The government is now securing reserves of gas (92 percent of storage capacity is full, but it only cover 10-15 percent of annual demand), as well as coal. The task for the coming winter will be to ensure the supply of fuel for all customers. Not enough is being done to replace stoves, which in itself could significantly reduce fuel needs. On the other hand, the situation creates an opportunity for suppliers and distributors, who take advantage of the situation to increase margins and raise energy prices for retail customers.
What tools should the state use to fight the crisis?
Fiscal policy will provide an important context for the potential of monetary policy to bring inflation under control quickly. Until 2020, its nature in Poland was mixed – on the one hand, it maintained a course to control deficits and reduce public debt, on the other hand, it shifted the structure of state spending towards social transfers, stimulating consumer demand on a scale of approx. 4 percent of GDP at the expense of investment demand (a decrease of approx. 2 percent of GDP). At the time of the pandemic, the country had dramatically increased its borrowing needs by as much as approx. 8 percent of the GDP, spending the funds to subsidize companies and maintain jobs. This allowed for a rapid return of consumption and production to pre-pandemic levels, but also contributed to an increase in core inflation well above the levels seen in most other OECD countries.
Today, unanimity is necessary in the Polish policy-mix in the monetary and fiscal area. In the monetary area – monetary policy tightening, which means raising central bank rates at a rate exceeding – on an annual basis – by approx. 2 percentage points of the currently announced path. This would translate into an increase in the (reference) interest rate to approx. 9 percent at the turn of the 3rd and 4th quarter of 2022. In addition to a more ambitious interest rate, a more active policy is needed to reduce the banking sector’s excess liquidity caused by loose monetary policy in the past.
The greater the effectiveness of monetary tightening, the better the coordination with fiscal policy. Considering the clear signs that the Polish economy is overheating, this means the revenue and expenditure policies need to be adjusted. The government should supplement the changes in direct taxes („Polski Ład”) with reforms in indirect taxes, increasing revenues from them by approx. 3-4% of GDP. This can be achieved by harmonizing the VAT at 22-25% and significantly increasing excise duties on second-hand goods (alcohol, cigarettes, etc.), and luxury durable goods (e.g. large cars).
What role is played by energy saving on the one hand and social aid on the other? How do we reconcile them?
Energy poverty and ensuring that no one runs out of heat during the heating season is a very important issue. There may be proposals from the government for coal subsidies for the poorest people, but they should be linked to the replacement of heat sources in this or the next heating season. Aid should also be limited to the genuinely poorest households-for the rest, high prices will encourage change. The government should actively promote energy saving by using, among others, funds from the National Recovery Plan.
Interview by Wojciech Jakóbik