When last we visited little Hungary and the forint, its central bank was cutting rates in an attempt to stimulate growth in the face of a recession. Its inflation rate is rising, but its growth is shrinking; this condition is known as “stagflation.”
Hungary is proverbially between a rock and a hard place. Its main trading partner, the EU, is in the midst of a recession reducing demand for its goods. At the same time, the loose money policies of the developed world’s central banks have caused food and energy price inflation.
As you can see from the chart above, the effects of this inflation are milder in richer countries, because food and energy account for less of a share of disposable than in poorer ones.
In Hungary, food accounts for nearly one fifth of the typical household’s budget. This is nearly three times the ratio as that of the U.S. and twice that of Germany.
The best way a central bank can deal with stagflation is to raise interest rates until inflation is halted. The problem with this action is that it will cause a very deep recession, and Hungary is already reeling from one with 1.2% contraction in GDP for the latest quarter. Tightening could cause a depression.
Central bank action is creating many unintended consequences. The worst of which is political instability in the world. One of the causes of the Arab Spring was food and energy price inflation. Hungary has a deeply divided electorate, and people should pay attention to unfolding events there.