Inflation is a curious beast. That is, it is if you think about it a little more than the average economist does.
The central banker's view is that all inflation is ultimately down to the availability of too much money in the hands of those consumers who must work for a living. This either creates demand-pull inflation, because those in work have already been paid too much, or it creates cost-push inflation because those workers are demanding to be paid too much in the future. In either case their answer is the same. The income of those in work must be crushed. Jobs must be lost. Poverty must be imposed. Recession must be endured. And it's all the fault of greedy, overpaid employees, whose spirits must be destroyed by forcing them into expensive debt for a significant period until such time as they learn their lesson and stop being greedy.
In the real world inflation is nothing like that. The current inflation has been caused by three things. One was the disorderly and unpredictable reopening after Covid, which few could have predicted when it happened because the pandemic was very clearly not over by then. This created short term demand that disrupted supply chains could not match. Inflation resulted.
The second cause has been continuing disruption in supply chains, whether for energy or other products, having been exploited by rent-seeking, profit maximising companies willing to exploit consumers who they believed had money to spend. In the confusion of reopening this profit-seeking behaviour became possible as price expectations had become disrupted during lockdowns that were released far too quickly, and without any, let alone adequate, planning.
Third, there has been war, which has exacerbated the energy price inflation dramatically and added in food price inflation in various ways.
In all this wage inflation has been below consumer price increases. Consumers have too little and not too much to spend right now.
The cause of the current inflation is in that case nothing like that which the central banker's model suggests. Their prescription to cure inflation is also, inevitably, wrong in that case. So, more than ever what they are doing simply looks like a case of class warfare being waged by them rather than any form of rational economic policy. Interest rate rises, themselves inherently inflationary because they increase the cost of money, are no solution to this crisis.
What is then? The key to answering that question is to understand what is likely to happen in the medium term, once the short term inflationary pressure we are now facing end. I make three assumptions. The first is that the war in Ukraine will end, or (and I am aware of how heartless this sounds, and it is not meant to be) it will be contained in a continuing war of attrition around which the world economy will be reorganised. I think either of these is very likely. I accept the war could escalate, which changes everything, but I think it is unlikely.
Second, supply chain disruptions will resolve as the world comes to an accommodation with Covid. I think that may be a very costly accommodation as it becomes apparent just how harmful this disease will be in the long term, with likely significant falls in life expectancy resulting, but again, purely economically that accommodation will be found.
Third, in a stabilised world profit-taking, whether by second-hand car dealers, or banks, or energy suppliers, will be harder to sustain. In most cases prices that are currently being seriously inflated are likely to fall significantly, as supply chains are sorted and a new stability returns. Second-hand car prices will return to normal. Interest rates will decline to near zero again. And fuel prices will go down, significantly, not least as green alternatives kick in. I only see a possible exception in the case of food. There real disruption resulting from sanctions on Russia and disruption in Ukraine will have an impact for longer, but again, consumer patterns may adapt to counter this.
Overall, what this means is that in the medium term I suspect significant price falls are going to be seen in the economy. There will quite likely be deflation. Even the shortage of money in consumer hands, which I think will continue, not least because of the combined callous indifference of central bankers and many governments, will require this. Businesses will ultimately be forced to price their products to what the market can afford or go out of business.
Why raise this issue now? Because what it suggests are three things.
First, if inflation is to be a short term phenomenon what are required are fixes that take the peaks out of the price rises. That is things like cutting duties and indirect taxes, whilst simultaneously helping those in real need. Smoothing the path back to normality is what is required, and large wage increases are very unlikely to become the new normal as yet, even if central bankers think otherwise.
Second, windfall taxes and taxes on those parts of the economy where inflationary pressure is real because there is too much money in well-off consumer's hands are necessary. So, energy company profits should be taxed more. Banks should also be looked at. But so too should taxes on high income and wealth rise as this where the inflationary pressures are.
Third, we need to invest. When there are falling prices investment falls as people defer spending, presuming goods will be cheaper in the future. There is a strong recessionary element to deflation in that case. So, investment to create jobs is essential and the planning has to happen now.
Is there anything we do not need? There is, of course. That is interest rate rises that can only make all the current scenarios worse.
If only central bankers would stop waging class warfare and did instead actually think about the causes of the inflation we have we might get significantly better policy to manage our current economic crisis. I am not confident that those in charge are capable of that though. And that's the worry, because if we get deflation, which I think much more likely than stagflation, we are in more trouble and won't have prepared for it, yet again.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
Your explanation of current policy in your second large paragraph is the best one I’ve ever read about what can only be described as the economic penal system that imposed on the citizens of this and any many other countries.
It’s also just a comfort blanket for lazy central bankers so as not to upset their friends in high places and high income brackets.
Woeful.
I have to admit I thought that quite good…
Across the sectors I look at I would add another inflation component SPECIFIC to the UK – wage pressures because of Brexit. This coupled with a significant drift away from employment in the post 50’s (also in the US, but not so much in the rest of Europe) and long Covid (anecdotally I think that this is higher in the UK than elsewhere) means that this component of cost pressure will be long term in the UK.
you continually dismiss the money supply as having any impact on inflation which is quite bizarre..you continually focus on a micro aspect of the economy namely those at the bottom end of the pay scale. This is both noble and important but this area cannot be used as a behavioural antidote for the broader economy. The fact is we have had rock bottom interest rates for nearly 10yrs. Credit is cheap so those who can take advantage. it might be buying a first house, buying a bigger house, funding home improvements, buying a car a washing machine a new TV a new smartphone or whatever. The point is low interest rates and by that i consider long term rates suppressed by QE as important as it has fuelled massive increase in mortgages and house price inflation. And the more the house is worth the more wealthier people feel so they spend more. It all feeds through to consumption. So the money supply undoubtedly fuels consumption and with the supply shocks they all contribute to inflation… and right now inflation at these levels is a killer, an absolute destroyer of economies.
so yes by all means consider inequality and highlight the needs of those at the bottom end of the pay scale. But to consider the money supply and inflation is not linked is just plain wrong. You have got the call on inflation completely wrong, you need to acknowledge that. And yes deflation is also destroys economies but apart from the occasional quarter that is not something we see and certainly isn’t valid today.
Go on then: answer this questiion.
First, why has a much bigger money supply in Japan never delivered inflation?
And who did QE not do so for 11 years here, but inflation started when supply chain shocks and war happened.
Precise explanations as to why it happened now, please, and no other time
Please also place in an historical time frame since say 1970 and explain when money supply came remotely near causing inflation in that period in the UK
If you can’t (and it’s not possible) shut up. If you can, fully worked explanation, please….my email is easy to find
No theory – actual evidence please
Gerald, you have it the wrong way round. An increase in the money supply follows after the inflation because economic actors need more money in order to maintain the same level of real activity. The central bank has little choice but to accommodate that. A question for you – Sterling M4 (broad money, including bank deposits and gilts up to 5 years – note that is acknowledging the ‘National Debt’ is actually part of our money supply) has gone from £1 trillion in 2000 to about £3.5 trillion now. Does that not mean we have had two decades of hyperinflation?
What actually has happened is the velocity of circulation has more than halved so a lot more money is now stuck in the savings of the wealthy as inequality has increased. Taxing it back into circulation or Richard’s plan to divert it into the GND might be much better for all. Money that does not circulate is of little use to the economy.
You are right Tim
Banks used to be better run and actually interested in helping their clients. Managers used to ask their clients to drop in for a chat once a year to see how they were getting on. I used to like my bank manager. Now, I don’t really have one. I didn’t mind the self interest behind those modest interventions. Now, they are simply rapacious, captured by the neoliberal mind set.
If you define “inflation” as a persistently rising, general price level then I am not sure that we are experiencing “inflation”. The price rises are limited to particular things driven by supply constraints and earnings are lagging price rises leaving little chance of increasing prices become persistent. What we are seeing is chaos as markets try to adjust to massive changes…. with ordinary folk caught up as collateral damage. In some way perhaps the CB should step back and see how things settle down… with the government doing what it can to ameliorate things for the most vulnerable. Only then should the BOE act on inflation (if they need to) – after all, inflation may be bad but economic destruction is worse.
The idea that making poor people poorer will cut prices is laughable… but this view is held by those in power – and that is NO laughing matter.
As a footnote, US 10 year yields hit 3% and the Quarterly US Treasury auctions are a week away……. Could get ugly!
Noted
treasury yields have been suppressed by QE we all know that. Without QE and with bond markets left to their own devices then long dated bonds should yield a real return like historically they have. So yes without Central Bank intervention it could be a bloodbath. I wouldn’t own duration at the moment.
Tell me about long term rates Gerald
What’s the trajectory right now per the Bank of England using 500 years of data?
“The idea that making poor people poorer will cut prices is laughable… but this view is held by those in power – and that is NO laughing matter.”
Let’s not forget that the less money a person has, or the poorer you are, the more of your income will be spent on those things that you need and this is where I have a bee in my bonnet when it comes to official rates of inflation and how it is measured.
The first “bee” is the fact that house prices are not included. I’ve been a lifelong renter and I would say that around 40% or more of my income, historically, has gone to a landlord every year. Then there are the other “bees”. Another decent chunk goes to the local council for Council Tax. Another chunk, getting bigger all the time, is for energy, gas, electricity, water. Government, historically, tells me there is no or little inflation. Economists have been saying the same for years. It’s not there because it isn’t being measured, at least not proportionally to what people need and earn. We can now add in food and clothing, which historically prices were kept reasonably low, but now that is no longer a cheap option. Even broadband. I don’t think any of the BB providers that I’ve used have ever put up their prices each year by just the rate of inflation. When inflation was supposedly around 1% their bills would come in at 15-20% increase every year. Mine went up by about 6% this year, official inflation finally catching up with it.
We have an inflation index that is largely made up of crap that we don’t need, but even that is going up now and will pay the price as we all have less discretionary spending as it will increasingly go on the things we need.
As for deflation, what I fear is that once this inflationary cycle is complete, heaven knows where prices will be on everything we need. I can easily imagine that in this environment within 5 years the average price of a house will be £500,000. I fear we may need a deflation shock, prices collapsing to bring our dumb politicians back down to earth.
As an aside take current gas and electricity prices, if and when the market corrects downwards I think it should all be passed on to the consumer. I bet it won’t be. We will be lucky to get a few % decrease. Once inflation has set in on things we need it has a tendency to stay. Can anybody name anything that we NEED that has ever over time come down in price? Even in real terms?
Another “bee”. BP – Announces £5 billion of profits today. No doubt they will be raising a glass of bubbly today.
https://uk.news.yahoo.com/boris-johnson-rules-windfall-tax-084200026.html
Sorry for my frustration, but I now feel we are paying the price for years of incompetence when it comes to how inflation is measured, and the lack of political will to address real inflation in those things that we need, which to some degree has always been there for the less well off or poor.
Thank you for sharing your frustrations
Interesting report from todays Grauniad, might be an idea to deal with deflation and asset price inflation in one go
https://www.theguardian.com/business/2022/may/03/most-britons-back-curbs-on-bosses-pay-survey-finds
The other thing central bankers assume is that inflation is uniform. ie that all prices go up in step. This is not the case. As you state price rises currently are specific to circumstance. Second hand cars are up because no one is buying new because of chip shortages. Food is up because of war, brexit and covid etc etc. There will be other areas where prices are falling. None of the inflation is caused by excess money. Policy needs to be targeted.
As an aside I see no one is questioning where the money is coming from and how will it be paid back for the Tory policy of supplying arms etc to Ukraine. Why is that? It seems that the cost of Covid has to be repaid according to Rishi and the Treasury. Will there not be an NI hike for the war cost or maybe a charge on pensioners?
There is no need for increases for that reason….
What I find odd throughout these and other articles is the way in which elements such as prices, inflation, costs, interest rates, etc., are referred to and deemed as ‘things or beings’ in their own right as if they have agency! In my simple head all these things are not graced with agency, but are the result of people making decisions, i.e. to increase a cost, a price, etc. So, unless the actual cost of producing a good or service, e.g. renewable electricity, is increasing, then someone or a company is making more money by putting up the cost/prices. Someone is deciding to increase or decrease prices and making a profit on the back of consumers. I appreciate there is a market, and yet here too this is driven by human decisions to do something, such as push up prices, someone is still making all the money! Am I wrong?
No
Despite all the financial pressures upon us, funds can always be found for military purposes:
https://www.bbc.co.uk/news/live/world-europe-61295448
A couple of days ago a friend of mine was sent a Tour-of-the-Economic-Horizon summary from a company describing themselves as Investment managers, so the usual reverse Robin Hood types.
The phrase that immediately caught my eye was “consumers are in a really good place right now”.
You can imagine their forebears saying much the same during the Irish Potato Famine.