The Cobweb model was first introduced by Kaldor (1934) for the agricultural sector. This model then developed continuously by incorporating an element of expectation into it (Kaldor [1958] and Pashigian [2008]).
By
ARI KUNCORO
·5 minutes read
AP/KIN CHEUNG
A man stands in front of the Bank of England, at the financial district in London, Thursday, Nov. 3, 2022. The Bank of England has announced its biggest interest rate increase in three decades as it tries to beat back stubbornly high inflation fueled by Russia's invasion of Ukraine and the disastrous economic policies of former Prime Minister Liz Truss.
The annual inflation in the United States declined significantly from 8.5 percent in August and 8.2 percent September to 7.7 percent in October. Meanwhile, inflation in the Eurozone has shown no signs of abating. Monthly inflation in October was recorded at 10.7 percent, higher than 9.9 percent in the previous month.
Meanwhile, inflation in the United Kingdom in September amounted to 10.1 percent, the highest in 40 years, up from 9.9 percent in the previous month. These different inflationary pressures occurred because of the different interactions between the demand and production sides, the dynamics of which can be graphically depicted by a spider web-like diagram (Cobweb).
The Cobweb model was first introduced by Kaldor (1934) for the agricultural sector. This model then developed continuously by incorporating an element of expectation into it (Kaldor [1958] and Pashigian [2008]). Previously this model was considered antiquated, because it assumes the formation of adaptive expectations or expectations looking back and not forward (forward-looking).
However, the decline in social welfare in Western industrialized countries as a result of high inflation has caused attention to outdated models to reemerge (Martin and Schuman [1997]). Stein (1992) incorporated rational and forward-looking expectations so that this model became more relevant to current situations, mainly to explain global inflation originating from the food and energy crisis as a consequence of the Russia-Ukraine conflict.
The prediction from the Cobweb model is that if inflation expectations are an incentive for increased production due to higher demand-side prices, inflationary pressures will ease. On the other hand, if inflation increases production costs more quickly and demand-side price increases are slower than the increase in production costs, as a result, inflation will be higher and more explosive, and may even become hyperinflation if not managed properly.
AFP/GETTY IMAGES/MICHAEL M. SANTIAGO
Traders work on the floor of the New York Stock Exchange during morning trading on Nov. 2, 2022 in New York City. Stocks opened low this morning as the Federal Reserve is expected to make a fourth straight interest hike of of three-quarters of a percentage point fueling recession fears as it continues to fight inflation.
Demand and production side interactions
In the economy, the production side is influenced by various expectations such as product-selling prices, raw-material and labor costs and interest costs for working capital. The increase in the benchmark rate by the United States central bank (The Fed) affected the production side as seen in the decline in the purchasing managers' index (PMI) for manufacturing procurement, from 50.9 in September to 50.2 in October. Both figures are still above 50, which is the boundary between expansion and contraction of production.
The facts show that the 75 basis-point rate hike has occurred four times since June 2022.
The effect did reduce PMI, but never fell below 50. The US inflation rate of 7.7 percent shows that in the context of the Cobweb model, the increase in inflation is still maintained by production expansion so that inflation can drop significantly, although it is still far above the ideal amount desired by the Fed.
AFP/DANIEL ROLAND
The headquarters of the European Central Bank (ECB) is pictured prior to the news conference of the bank's governing council following their meeting in Frankfurt am Main, western Germany, on September 8, 2022.
Convergence of inflation to a lower pace is yet to be seen in the United Kingdom or the Eurozone. Inflation figures in the UK continued to increase, even though the Bank of England (BOE) raised its benchmark interest rate by the same amount as the Fed. Inflation was recorded at 10.1 percent in September, up from 9.9 percent in the previous month. In fact, what happened was that the production side was hit with an increase in interest rates for working-capital loans. The PMI in October was in the contraction zone at 48.8 so that the output gap persisted, which kept inflationary pressures on the rise. In terms of food and energy, the UK and the Eurozone do have more limited options than the US.
The situation in the Eurozone is not too different. The European Central Bank (ECB) followed in the footsteps of the Fed by increasing its benchmark interest rate by the same magnitude. As a result, inflation continued to increase from 9.9 percent to 10.7 percent in October. An increasing gap between the demand and production sides persists. The production side continues to show weakness with the PMI decreasing from 46.6 in September to 46.4 in October.
Lessons to be learned
The situation for the UK and the Eurozone is in line with the prediction of Obstfeld (2022), a former IMF Chief Economist, that if other central banks try to replicate the size of the Fed's rate hike on a point-to-point matchup, the risk is overkill with the potential for world stagflation.
The Cobweb phenomenon is also seen at the microlevel where several commodities, such as red chilies, shallots and chicken meat, which in the previous month contributed to inflation, are now contributing to deflation.
In terms of expectations, the interaction of demand and production in Indonesia can be seen from the development of the consumer confidence index (IKK) issued by Bank Indonesia and the PMI published by Trading Economics. The effects of global uncertainty are recorded in the Consumer Price Index (CPI) and PMI. PMI for October was recorded at 51.8, down from 53.7 in the previous month. Meanwhile, the CPI decreased significantly from 124.7 in August to 117.2 in September. Nevertheless, these two quantities are still in the optimistic-expansion zone. In the terminology of the Cobweb model, this allows for a reduction in the demand and production gap, so that inflationary pressures decrease from 5.95 in September to 5.71 percent in October.
The Cobweb phenomenon is also seen at the microlevel where several commodities, such as red chilies, shallots and chicken meat, which in the previous month contributed to inflation, are now contributing to deflation. It seems that its supply network is responding to rising prices with increased supply.
The increase in Bank Indonesia's benchmark interest rate by 50 points is not a point-to-point matchup with the Fed, but is more directed at controlling inflation expectations and not burdening growth. In general, the annual growth of 5.72 percent in the third quarter of 2022 also supports the Cobweb phenomenon.
ARI KUNCORO, Rector of the University of Indonesia
