By JAYATI GHOSH*
The dearth of creative thinking about the causes of and responses to inflation reflects the sorry state of economic discipline.
The inflationary wave has revealed several things about current governments, but also, more patently, about economists. The number of economists, and therefore policymakers, who remain trapped in the adamant idea that inflation results from too loose monetary policy – and that, therefore, central banks should restrict the money supply and raise interest rates. interest – is huge. This is something John K. Galbraith would have called "conventional wisdom."
But this is wrong. The causes of inflation vary according to context and period. Tighter monetary policy is a dangerous tool that risks generating recession and unemployment – hurting workers even more than the price rises themselves. But this policy does not only cause human suffering, because if the engines of inflation are different, reducing the supposedly guilty excess demand will not solve the problem.
These obvious facts seem almost forgotten in conventional discussion. Even respected economist Olivier Blanchard, in a series of tweets, suggested that rising unemployment was the only way to control inflation. The problem, apparently, was how to get workers to understand and accept this.
A thought that fights against inflation, according to him, faces beliefs: (1) When inflation comes from overheating, it is difficult to convince workers that the economy needs to slow down and that unemployment needs to increase to control inflation, but at least logic can be explained; (2) When inflation comes from an increase in prices of commodities and energy, it is even more difficult to convince workers that unemployment must rise to control inflation. “Why should I lose my job if it was Vladimir Putin who invaded Ukraine?” – they think; (3) This makes the work and communication strategy of central banks very difficult.
Do not accept, dear reader, the highly problematic statement that “unemployment has to increase to control inflation”; it has been effectively refuted, conceptually and empirically, over the past two decades. Consider, furthermore, the possibility that the driver of price increases is not “excess demand” or demands made by workers to raise wages. The triggering cause of inflation is not "they are not being properly 'disciplined' by unemployment". It is found in corporate speculation, along with financial speculation in the equity markets. commodities.
There is good reason to believe that this is the case, especially in global markets and advanced economies. In many low- and middle-income countries, the causes of inflation are more complex and come primarily from cost-increasing factors, including imported global price inflation and currency depreciations.
corporate profit
In the United States, for example, the Economic Policy Institute showed that rising corporate profits contributed disproportionately to inflation. From the second quarter of 2020 to the last quarter of 2021, corporate profits accounted for 54% of overall inflation – a dramatic increase from the 11% they accounted for over the previous four decades (1979-2019).
In contrast, unit labor costs accounted for less than 8% of inflation, compared with 62% over the previous four decades. In fact, because of recent price increases, the real federal minimum wage is now at its lowest point in 66 years! The contribution of non-labor input costs – the famously publicized “supply chain breaks” – was 38%, compared to 27% in the previous period.
Companies' ability to increase profit margins can come from increased demand. The pent-up demand from households that were unable to spend heavily during the pandemic may have had an effect, especially given the massive fiscal stimulus by successive US administrations.
But a much larger role was played by increasing concentration and monopoly power in the industry. Massively increased corporate profits were most evident in energy, food and pharmaceuticals, as supply shortages resulting from the war in Ukraine became a convenient excuse for disproportionate price increases.
strong predictor
The surveys of Roosevelt Institute show that in 2021, US companies increased their margins and profits at the fastest annual pace since 1955, taking both to their highest absolute levels since the booming postwar decade. The researchers note that pre-pandemic profit margins were a strong predictor of margin increases in 2021, making market power a significant driver of inflation.
While the public perception that the current food crisis could generate war-related supply shocks, it was actually the behavior of companies that proved most significant. Major grain trading agro-industries experienced dramatic increases in profitability in January-March 2022. They raised their prices without being questioned – as all observers made the assumption that this was in the face of war-caused shortages.
Financial speculation, such as occurs in wheat futures markets, has driven up prices even in spot markets; the recent decline in wheat prices, in turn, similarly reflects changes in futures contracts. Now this is typical of speculative bubbles, which, while often driven by news, also tend to be affected by herd behavior rather than real-world events.
This increase in speculative activity is confirmed by the important work of Agarwal, Lei Win and Gibbs. Lo and behold, they followed the activities of financial investors (mutual funds in particular) in commodity markets. They found that, for example, “in the Paris milling wheat market, the benchmark for Europe, speculators' share of buy-side wheat futures increased from 23% of open interest in May 2018 to 72% in April 2022”. Likewise, in May 2022, speculators' so-called long positions (buy positions) constituted more than 50% of the price increment in wheat varieties"hard and soft red winter".
regulatory action
If the recent increases in global prices – which translate into varying degrees of inflation in different countries – are driven by such factors, then the policy response should be very different from using the dangerous instrument of aggregate monetary policy. Instead, it should focus on regulatory actions to curb monopoly power and financial speculation.
Taxation of excess profits may be a deterrent to such behavior in the future, but specific actions to control the prices of strategic commodities also play a role, as Isabella Weber noted. Those who have criticized such policies seem to be ignorant of both the history and the wider experience.
The dearth of creative thinking about the causes of and responses to inflation reflects the sorry state of economic discipline. This is likely to have serious consequences, economically and politically.
*Jayati Ghosh is a professor of economics at the University of Massachusetts, Amherst..
Translation: Eleutério FS Prado.
Originally published on the portal SocialEurope.
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