Friday, December 2, 2022

The truth of inflation

Inflation is everywhere. India’s retail inflation is at a five-month high; in the UK it is back in double digits, the highest it has been in 40 years; in Japan inflation has hit an eight-year high; in Europe bread prices are up nearly 20%; shops and businesses in Ghana have gone on a strike in protest against the whopping 37% inflation rate. Across the world, taming inflation has become the biggest priority for governments and central banks.
IMF’s latest World Economic Outlook says that ‘increasing price pressures remain the most immediate threat to current and future prosperity by squeezing real incomes and undermining macroeconomic stability’. Economists and commentators all agree that there are three key culprits of this high inflation. The first is the large welfare spending done by governments during Covid and the ‘loose money’ policies followed by central banks to boost investments. The second is Russia’s invasion of Ukraine, which has disrupted supplies of gas, wheat and cooking oils. The third is China’s ‘zero-Covid’ policy, which has caused supply disruptions from the ‘factory of the world’. To sum it up, inflation has been caused by the three enemies of neoliberal economics — welfare spending, Russia and China.
How should countries deal with this crisis? The IMF’s prescriptions are broadly what all mainstream economists agree on: cut government spending and tighten money supply. Reduced subsidies and government spending will take the extra ‘unearned’ money out of the hands of households and make them spend less on goods and services. Higher interest rates will make businesses think twice before taking loans to buy machines and raw materials, bringing down the demand for industrial inputs.
Calibrating interest rates and fiscal cut-backs will be a difficult task. Economists admit that removing subsidies and incentives and raising interest rates might cause economies to slow down. But the mainstream consensus is that not doing it is a bigger inflation risk. The IMF, for instance, says that it is better to over-tighten than under-tighten. It recognises that this recommendation will be a difficult political pill to swallow. It says, ‘As economies start slowing down… calls for a pivot towards looser monetary conditions will inevitably become louder… but central banks around the world need to keep a steady hand with monetary policy firmly fixed on taming inflation.’
There are three questions to be asked here. The first is whether inflation is really a bad thing that would justify the neoliberal obsession with curbing it. The second is whether curbing inflation helps long-term economic growth by reducing uncertainties. The third is whether inflation is actually caused by higher demand in a low supply environment or something else is the real culprit.
Inflation is bad only if it is caused by more money chasing fewer goods. Prices can rise even when supplies go up. After all, things do cost more than they did a century ago, even though the availability of goods and services have gone up dramatically. In other words, as long as money incomes rise at a faster pace than prices, real incomes will rise in spite of inflation. If anything, a certain amount of inflation — both in goods and wages — is needed for both entrepreneurs and employees to ‘feel’ that their profits and incomes are going up. People cannot sense real income growth in a deflationary atmosphere, if returns to capital and labour fall.
Neoliberal economists, who have determined government and central bank policies across the world for the past 30 years, claim that high inflation dampens investment. They argue that entrepreneurs invest expecting predictable returns, which, in turn, requires a stable inflation outlook. And if investments fall, economic growth slows down as well. This belief has informed central bank policies of inflation targeting, including in India.
But what does this show? In the US, inflation-targeting caused a drop in the average annual investment rate from 22.6% of GDP to 21%; in the UK, it fell from 23.2% to 17.5%; and in Germany inflation-targeting pushed the investment-GDP ratio from an annual average of 24.8% to 21.4%. The impact on growth was the same. Inflation-targeting in the US brought the inflation rate down from an average of 5.1% to 2.4%, but it also brought GDP growth down from 2.5% to 1.5%. In the UK, inflation fell from 8% to 2.5%, but growth too dropped from 2.5% to 1.3%. In Germany, the inflation rate was brought down from 3.4% to 2.5%, but the average GDP growth halved from 2.5% to 1.2%. Labour productivity has also fallen across the world wherever inflation-targeting has been introduced as a central bank policy.
One could argue that the current situation is different because there are genuine supply shortages due to the Russia-Ukraine war and China’s supply disruptions. In such a scenario, there is no option but to bring inflation down, even at the cost of growth and investments. But this is a falsehood being pushed by neoliberal economists and Bretton Woods institutions. Across the world, it is supernormal corporate profits which are the real cause for high inflation. In the US, between 1979 and 2019, when inflation has been relatively low, higher wages accounted for 62% of the rise in the price of goods, raw materials, machines and other inputs accounted for 27% and corporate profits 11%. In the past two years, when inflation surged to a four-decade high, wages accounted for just 8% of the rise in prices, inputs 38%, and corporate profits 54%.
In other words, it is corporate profits which are causing inflation right now and not supply disruptions from Russia and China or higher welfare spending by governments. The IMF-World Bank-neoliberal economist lobbies will never tell you that. Because mainstream economics is just an apologia for corporate greed, and that is why the corporate-controlled media spreads it as an absolute truth that must always be followed by every government.
Aunindyo Chakravarty, Senior Economic Analyst

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