Price rises should be short-lived – so let’s not resurrect inflation as a bogeyman | William Mitchell

Until full employment is reached, governments need not cut back on public spending

A decade ago the financial press, echoing predictions from mainstream macroeconomists, obsessed about whether governments would run out of money as deficits rose to combat the global financial crisis. Stark predictions of rising bond yields and inevitable debt defaults came to nought.

Now, with much larger deficits, the headlines are all about inflation. No one seems worried any longer about government insolvency as capitalism survives on fiscal life-support systems. The focus has shifted from meaningless financial ratios to substantive issues relating to real resource scarcity (that is, how close nations are to full employment). However, the inflation mania is as misconstrued as the earlier solvency fears.

Lurid statements, like this in the Wall Street Journal: “Anxiety about inflation is at a fever pitch, among economists and in markets” and this headline in the Dow Jones-owned Marketwatch: “The biggest ‘inflation scare’ in 40 years is coming”, feed the frenzy. Apparently, rising household saving during the lockdowns will become an expenditure binge as restrictions ease. Accordingly, the former US treasury secretary Larry Summers claimed that Biden’s fiscal injections would “overheat” the economy and cause accelerating inflation.

The former German finance minister Wolfgang Schäuble has also claimed that accelerating inflation will result from the European Central Bank’s public bond-buying programme, which has purchased most of the eurozone government debt issued since the pandemic began. He wants a return to austerity or “monetary and fiscal normality”, a normality that maintained elevated unemployment levels and stagnant growth.

Inflation hawks claim the large deficits and central bank bond buying programmes – quantitative easing, or QE, which is mischaracterised as “money printing” – will deliver Zimbabwe-like outcomes. However, they just misunderstand how governments spend and are ignorant of the history of hyperinflations.

All government spending is facilitated by central banks typing numbers into bank accounts. There is no spending out of taxes or bond sales or “printing” going on. All spending – public or non-government – carries inflation risk if nominal spending growth outstrips productive capacity. As full employment is reached, governments have to constrain spending growth and may have to increase taxes to curtail private purchasing power. But we are a long way from that point, with elevated levels of unemployment and largely flat wages growth.

Japan’s experience since the 1990s demonstrates the spurious nature of mainstream macroeconomics, which erroneously predicted bond market revolts and accelerating inflation in the face of its large deficits and QE programme, which most nations have now copied. Modern monetary theory (MMT) demonstrates that QE involves central banks buying government bonds by adding cash to bank reserves. Bank lending is not constrained by available reserves – they are never loaned out to consumers. Rather, lending is driven by demand from credit-worthy borrowers, who are thin on the ground in deep recessions. The only way that QE can stimulate total spending is via its capacity to lower interest rates. When the central bank buys bonds in the secondary markets, the increased demand reduces yields and this permeates into lower rates for relates financial assets. The lower bond yields may have stimulated increased demand for equities, but they have not pushed total spending beyond resource constraints

Further, massive supply shocks explain the hyperinflation of 1920s Germany and modern-day Zimbabwe. The Zimbabwean government’s confiscation of highly productive white-run farms to reward soldiers who had no experience in farming, caused farm output to collapse, which then damaged manufacturing. Even with fiscal surpluses, hyperinflation would have occurred, such was the supply contraction. The current supply chain disruptions are temporary and relatively small by comparison.

There are misconceptions as to what inflation actually is. Inflation is the continuous rise in the price level. A one-off price rise does not constitute inflation. For example, after recessions, firms often withdraw discounts and return prices to pre-recession levels. These adjustments do not constitute inflation. Share market booms are also not akin to generalised inflation.

Some price pressures have emerged as the pandemic eases. Oil prices fell sharply as the lockdowns kept us off the road. The increased demand for fuel, as cars have returned to the roads, is pushing up prices. But the Opec Reference Basket (ORB) for global oil prices is still below pre-pandemic levels and well below the stable post-global financial crisis levels. The US Energy Information Administration forecasts oil prices will flatten out through 2022.

Fearmongers point to the Opec hikes in October 1973, when global oil prices rose from an average 2.48 US dollars per barrel in 1972 to $11.58 in 1974. However, there is little prospect of a 1970s-style inflation emerging. Then, strong unions and firms with price-setting power engaged in a dispute aimed at shifting the real income losses from the rising oil prices on to each other. But the strength of the relationship between oil prices and inflation has waned since the 1990s. The ability of workers to engage in this sort of distributional struggle has been constrained by the rise of precarious work, persistent elevated levels of unemployment and underemployment, and pernicious legislation that has reduced union capacity to pursue wage demands. Since 1995, the IMF’s World Economic Outlook data shows that average annual inflation across advanced nations has been just 1.87%. In Japan, the average inflation rate has been 0.2%. A 1970s-style wages breakout will not happen.

Modern monetery theory draws attention to inflationary triggers that are independent of aggregate spending pressures: for example, administrative pricing practices (for example, indexation agreements with privatised energy or mass transport companies to increase prices irrespective of current conditions) and abuse of market power (such as cartels). Further, one of the problems the global financial crisis exposed, which has not been adequately dealt with, is the speculative move by hedge funds into agricultural commodity markets, which triggered massive food price increases in 2008. These triggers do require legislative focus.

I believe that the current price spikes, though, are transient, and will be absorbed without any entrenched inflation emerging. Accordingly, they do not justify a return to austerity.

  • William Mitchell is a professor of economics at the University of Newcastle, Australia, and docent professor of global political economy at the University of Helsinki, Finland. He is one of the co-founders of modern monetary theory

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William Mitchell

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