Regular readers will know that I think the current inflationary phenomenon is transitory. They will also know that I see the continual claims by financial market economists that central banks have to increase interest rates now to avoid an accelerating inflationary episode as having little economic content and lots of self interest content. If rates go up, they win their bets and the more they can bully authorities to do their bidding the more certain their bets become profitable. I am glad that central banks around the world are resisting that game of bluff. In previous periods, they have not resisted and have handed the financial speculators (the top-end-of-town) massive and unjustified profits and forced millions of workers to endure joblessness. It is also interesting that the mainstream press is starting to work that out too. Some progress.
Several readers have E-mailed me wondering what we mean when we say the inflationary pressures are emerging from the supply-side, which is different from a demand-side instigation.
Clearly, both the productive and spending sides of the economy interact to create an inflationary episode.
But the important point is to understand how that interaction changes to motivate a shift from stable prices to rising prices and then accelerating prices.
We can start thinking in this way.
The pandemic is a highly unusual event.
It has created a major imbalance in the relationship between spending and production.
Here is a graph from the latest US national accounts that helps us understand the issue at stake.
It shows the path of nominal GDP from the March-quarter 2010 to the September-quarter 2021.
The red line is the average quarterly growth rate up to the December-quarter 2019 (the peak before the pandemic) extrapolated out to the most recent quarter. It tells us what would have happened if the US economy had have continued growing on that average growth rate trajectory.
You can see that the economy has now just about recovered overall nominal spending levels – by the September-quarter 2021, the trend index was 107.2 points and the actual GDP was 106.9.
The next two graphs tell what was going on in the goods- and service-producing sectors to deliver this aggregate result.
The pandemic did three things in this context.
First, the government stimulus payments, though imperfect, helped maintain incomes and spending capacity among households.
Second, the lockdowns prevented consumers spending on services by and large – hospitality, entertainment, travel etc.
And with income still intact, the spending shifted to goods-production – renovations, gadgets, flat-screen TVs, you name it.
Households brought forward spending plans on some things while normal spending patterns were short-circuited by the inability to spend on other things.
What better way to assuage the uncertainty and boredom of a lockdown than buying a whole heap of gadgets and devices to start up once and then ignore (-:
Third, the lockdowns and health concerns also reduced the capacity of the goods-producing sector to meet the new demand. This is what we are referring to when we talk about supply-side bottlenecks.
If workers are locked down, getting sick, and ports and freight terminals are disrupted, the normal smooth supply chain is interrupted and so there are inventory shortfalls, delivery delays and the like.
Then overlay market power – which allows producers, wholesalers and retailers to profit gouge the shortages via mark-up increases and you see the problem.
The following graph shows the expenditure on goods in the US – actual and trend (calculated in the same way as before). You can see what happened.
The expenditure on goods has shot up – well above the previous trend, upon which decisions about productive capacity and investment were being made.
The supply-side in the productive goods sector simply cannot adjust that quickly to such rapid (and artificial) shifts in demand and so the conditions for price rises are in place, given the market power held by price setters.
The next graph shows why the total GDP (the first graph shown) has only just recovered to its pre-pandemic level, while expenditure on goods increased so much.
It shows expenditure on services in the US is recovering but still well below where it would have been had the pandemic not hit and the average growth path prior to the pandemic continued smoothly.
So the pandemic has created a combination of supply constraints and rapidly shifting demand patterns.
This is not the 1970s redux.
If the pandemic abates then those conditions will also abate.
That is the basis for my assessment that the current inflationary pressures are transient.
Transient doesn’t necessarily mean short-lived.
The pressures will last as long as the pandemic distorts the supply and demand sides of our systems.
There are signs that the distortions are easing – but then with omicron, things could change again for the worse.
Transient means that there are no structural forces that would see these initial price pressures morphing into an institutionalised wage-price spiral where labour and capital duke it out in distributional struggle to see which one has the power to force the other to bear the real income losses of the rising costs and prices.
That was the 1970s after the OPEC oil shocks imposed real income losses on nations via imported raw material price rises (oil) and both sides of the labour market had the market power to force price and wage rises, respectively onto the other.
Those conditions no longer exist in 2021.
The workers have largely lost that capacity – although, hopefully, the pandemic has altered the balance somewhat and workers will realise – even Amazon workers etc – that there is power in union.
There are signs that is happening – and not before time.
Mainstream press is finally waking up to the scam
For years, we have had to tolerate commentators in the mainstream financial and economic media playing along with the financial market ruses about artificial inflation panic.
The constant hype has been about how governments will lose control of their currencies if they don’t do what the financial markets think is ‘prudent’.
Of course, prudent has nothing to do with prudence in this context.
It is massage code (to keep us in the dark) for doing what the financial markets want so they can make huge profits and minimise their risks of losses.
So appeasement is about the government running the show so that the conditions are ripe for the speculators – the gamblers – to make money and damn the rest of us if they get in the way.
People are told – well, if the ‘markets’ don’t make large profits, we will not enjoy increases in our own wealth via pension/superannuation funds etc.
However, they are not told that the super funds charge massive ‘management’ fees and deliver rotten returns while ‘managing’ the savings of workers.
Our progressive political parties fell prey to the ‘markets’ must be appeased mantra.
Most recently, I wrote about how the British Labour Party leader thought that the priority was business profits because then everyone benefits – a factually false assertion.
Please read my blog post – When wages go up, we all benefit – what Starmer should have said (November 25, 2021) – for more discussion on this point.
All this talk about governments having to be fiscally responsible has nothing to do with them delivering full employment etc but everything to do with keeping a solid flow of risk free assets to the financial markets for them to price their risky products off and to flee to when things get uncertain in the private asset markets.
It has everything to do with ensuring they bail out the gamblers when they overreach.
With all that in mind, it is pleasing to read an article from the Sydney Morning Heral (December 6, 2021) – Panicking financial markets could stuff up another global recovery – by the economics editor, Ross Gittins that goes some way to recognising this game of bluff.
He notes that with inflationary pressures rising in the US and Britain:
… we’re witnessing a battle between people in the financial markets, who fear inflation is back with a vengeance and want interest rates up to get it back under control, and the central banks.
As you can see he hasn’t completely embraced my position.
The financial markets are not fearing inflation. They are using the inflation threat beat up to pressure for interest rate rises.
Their objective is to get interest rates up.
Because they have bet they will rise.
They have assumed that the central bankers will just bend over, as they have for the last few decades under this New Keynesian paradigm, and with their ‘forward-looking’ mentality push up rates.
The ‘forward-looking’ idea was that central bankers would hike if they ‘thought’ inflation might emerge down the track, even if there were no current pressures.
Their forecasting models to help them assess that condition were fraught – error-laden – and so we had the situation where monetary policy was always pushing against progress for no real reason.
And with fiscal policy being compliant – that is, not to ‘undermine’ the monetary policy stance – the surplus bias worsened matters.
The damage to economic growth and employment was not so much the elevated interest rates but the fiscal drag in combination with the rate rises.
So the financial markets thought that it would be a shoe-in this time around and bet accordingly.
If rates don’t go up, they will lose millions.
Hence the constant talk of inflation threats (code: put up rates you bastards so we can get our profits).
Gittins notes that:
The central bankers see the higher prices as a transitory consequence of the supply and energy disruptions arising from the pandemic. They fear that, once their economies have rebounded from the government-ordered lockdowns and fear-induced reluctance to venture forth, their economies will soon fall back to into the “secular stagnation” or weak-growth trap that gripped the advanced economies for more than a decade following the 2008 global financial crisis until the arrival of the pandemic early last year.
Exactly, although the low-growth wasn’t a structural matter but rather the consequence of the fiscal drag which was ideological and could have been reversed any time (as it was as the pandemic hit).
Secular stagnation would not be as easily reversed.
You can see from the graphs above, how quickly GDP has got back on trend in the US, which is a familiar story around the globe as governments have relaxed restrictions (for the time being).
So for once, the central bankers are not playing ball with the gamblers.
Gittins also argues (finally) that central bankers should:
… be less pre-emptive. Stop relying on theoretical estimates and just keep allowing the economy to grow until we had proof that wages really were taking off before we applied the interest-rate brakes.
And perhaps we should base decisions to raise rates on actual evidence of a problem with inflation – including, particularly, evidence of excessive growth in real wages – rather than on mere forecasts of rising inflation.
That is the shift that has accompanied the pandemic.
First, the US Federal Reserve decided to abandon the ‘forward-looking’ nonsense and not try to slow the economy while it is adding jobs and reducing unemployment.
In the past, the US Federal Reserve would have hiked rates several times already.
The new thinking – which effectively abandons the NAIRU culture that has hurt workers immeasurably – is welcome.
I wrote about that shift in thinking in more detail in this blog post – US Federal Reserve statement signals a new phase in the paradigm shift in macroeconomics (August 21, 2020).
The Reserve Bank of Australia has followed suit.
And the ECB and the Bank of England have also resisted the demands of the financial markets.
This is still what the central banks want to see: a new era of much lower unemployment and, as a consequence, much healthier rises in real wages to power a move to stronger economic growth than we saw in the decade before the pandemic.
But now Wall Street is panicking over the surprisingly big price rises caused by the pandemic’s disruption, and has convinced itself inflation’s taking off like a rocket. If the Fed doesn’t act quickly to jack up interest rates, high and rising inflation will become entrenched.
Wall Street is not panicking about inflation.
It is panicking because it fears that the central banks have actually changed the monetary policy paradigm and the bets they made based on an expectation that the old paradigm would return the moment the CPI ticked up will lose (millions).
Gittins thinks the “financial markets … have joined the inflation panic, betting that, despite all Lowe says to the contrary, our Reserve will be putting up rates continuously through the second half of next year.”
They haven’t joined the panic – they are trying to create that sense of panic because that way their bets win.
At least he understands that the ‘inflation panic’ narrative is all hype – “Apparently, this dramatic reversal in the economy’s fortunes has occurred without workers getting even one decent pay rise.”
The reversal being a return to the 1970s – as the ‘market’ commentators are trying to convince us of.
Gittins knows this is just hype:
There are three obvious weaknesses in this logic. First, globalisation has not made our economy a carbon copy of America’s. Second, there’s a big difference between a lot of one-off price rises and ongoing inflation. If the price rises don’t lead to higher wages, no inflation spiral.
Third, even if the central banks did get a bit worried, they’d start by ending and then reversing “quantitative easing” – creating money from thin air – before they got to raising the official interest rate.
I maintain my position that the inflationary pressures are transitory – how long that lasts depends on how long the pandemic distorts the spending and production systems.
And I hope the central bankers deliver massive losses to the financial markets by resisting the hype to hike rates.
That is enough for today!
(c) Copyright 2021 William Mitchell. All Rights Reserved.