The central bank dilemma

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By MICHAEL ROBERTS*

Stagnation seems much more likely than inflation; what happens to the latter will depend on factors beyond the control of central banks

“The inflation we got was not the inflation we expected,” said the president of the Federal Reserve, Jay Powell, at his press conference, after the monetary policy committee of the Fed decided to accelerate the “reduction” of its bond purchases to zero in March 2022. It then suggested that it would start raising the basic interest rate of the Fed, from zero to above.

What did Powell mean by the expression “not the inflation we expected”? He didn't just refer to the level of the inflation rate. US consumer goods and services inflation is now much higher than the forecast Fed in September, when its last meeting took place. This is also happening with so-called “core inflation,” a rate that excludes skyrocketing energy and food prices. Full inflation hit 6,5% in November, the highest rate in nearly 40 years.

But Jay Powell also referred to the causes of this rate of inflation. It appears that the Fed is no longer considering rising inflation as 'transient'. He seems to think it is likely to last for some time, although his average forecast is that the personal consumption inflation (PCE) rate will end at 5,3% in 2021. He thinks it should drop to 2,6% in 2022, and eventually to 2,1%, in 2024. In this sense, the Fed still assesses inflation as “quasi-transitory”, but it will be higher than previously thought, in the short term.

The reason there is a kind of “unexpected” inflation, Powell reckons, is due to the extraordinary circumstances of the pandemic. A normal rise in inflation, according to prevailing theory, would occur if too much money was pumped into the banking system; or perhaps it would come as a result of “tight” labor markets (ie low unemployment) and strong consumer demand as the economy expands. That's happening, Powell says, but the pandemic factor is adding traction on inflation: "These problems have been bigger and longer-lasting than anticipated, as they've been exacerbated by the waves of the coronavirus."

In other words, the pandemic has made inflation worse because of two causes: (1) there was pent-up consumer demand that was released as people moved to spend the savings accumulated during the lockdowns; (2) there are supply “bottlenecks” arising in an attempt to meet this demand – and these bottlenecks are being created by restrictions on the international transport of goods and components. As is known, much of the world is still suffering from the pandemic.

Therefore, the Fed is in a quandary. If you "tighten" monetary policy "too much", that is, raise interest rates "too quickly", it can cause the cost of borrowing to invest or spend to rise to the point where new investments in technology, as well as the consumer demand for products, decrease, thus generating an economic crisis. This appears to be the case given the record level of corporate debt. Alternatively, if you fail to act to reduce and stop the money supply, that is, if you fail to raise interest rates, then high inflation may cease to be transitory.

As a result of this difficulty, the Fed is looking for a compromise. The same applies to the Bank of England and the European Central Bank (ECB), which also met this week. Inflation rates in the eurozone and the UK also hit new highs.

UK annual inflation rate

In response, the Bank of England took a slightly different approach. It raised its interest rate by 0,25% but did not reduce bond purchases. The ECB is more concerned about stagflation than the Fed. The inflation rate may stay higher for longer in Britain because of Brexit's impact on imported goods prices and the loss of labor from EU migrants returning to Europe. What's more, the UK economy is already slowing down, not least because of the omicron variant.

The ECB is behaving more leniently because inflation has risen less than in the US or UK and the economic recovery has been slower. Furthermore, the variants of the pandemic are spreading rapidly in Europe. Therefore, the ECB did not raise rates at its meeting and only slightly redone its bond purchases. “Monetary easing” remains in effect in the eurozone and any interest rate hikes are postponed to 2023.

Annual inflation in the euro zone in %

In my opinion, the dilemma facing central banks – controlling inflation or avoiding a recession – is false. That's because monetary policy (pushing money in or out of credit, raising or lowering interest rates) is really ineffective at managing inflation or economic activity. Study after study has shown that “monetary easing” has had little or no effect on the development of the “real” economy or production and investment; study after study has shown that huge injections of cash credit by central banks over the last 20 years have not led to an acceleration of inflation – quite the contrary. So if the Fed, BoE or ECB accelerate monetary policy tightening, it will not work to “contain inflation”. Monetary policy doesn't work – at least at the interest rate levels that central banks are predicting.

Of course, if the Fed resort to interest rates that produce a rise in the real interest rate, that is, if it goes above inflation, similar to what former Fed chairman Paul Volcker did to end the high inflation rates of the 1970s. 20, this could work. The Fed's interest rate then reached a record high of 1980% in the late 11,6s, while inflation peaked at 1980% in March. But, as Volcker discovered, it still took years for inflation to come down significantly. Only after a strong economic recession, the worst of the post-war period until today, that is, between 1982 and XNUMX.

Why is monetary policy ineffective? As I have argued before, inflation is not a “monetary phenomenon” as the monetarist Milton Friedman argued. Nor is it the product of wage costs that push prices up.

a – despite constant attempts by UK government economists to make this claim. Recently, UK Treasury economists warned that “public sector wage increases “could” exacerbate temporary inflationary pressure”, contributing to higher wage demands throughout the economy… This argument has more to do with avoiding paying decent wages to workers of the public sector than with inflation.

I remind readers of what I have said before. There has never been inflation due to “wage pressure”. Indeed, over the past 20 years, real weekly wages have increased by just 0,4% per year on average, less than average annual real GDP growth of around 2%. It is the share of GDP growth that goes to increased profits. Marx argued that when wages rise, it will not lead to price increases, but to a fall in profits, and this is the real reason why mainstream economics makes such a fuss about wage-raising inflation.

If there are any “cost spikes” this year, it will be due to companies raising prices as the cost of raw materials, commodities and other inputs rises, in part due to the “supply chain” disruption due to COVID. The newspaper Financial Times reports that “price increases have emerged as a dominant theme in the quarterly earnings season that began in the US this month. Executives at Coca-Cola, Chipotle and appliance maker Whirlpool, as well as domestic brand giants Procter & Gamble and Kimberly-Clark, told analysts on conference calls last week that they were preparing to raise prices to offset rising consumer costs. inputs, especially commodities”.

Instead, output price inflation ultimately depends on what is happening with new value creation in the economy in question – and that depends on the rate of capital accumulation and the profitability of that capital. Inflation rates reached postwar lows in the 2010s despite quantitative easing as real GDP growth slowed along with investment and productivity growth. All monetary policy did was weakly counteract this downward pressure on price inflation.

On the other hand, “currency easing” actually ignited financial speculation and a stock and bond market boom, as zero cost borrowing plus unlimited money supply fueled the financial and real estate markets. There was a lot of inflation there. Thus, as the velocity of money (the turnover of transactions in the “real” economy) decreased, reducing the impact of monetary injections on productive investment and on the prices of goods and services, the prices of financial assets and other non-productive assets, such as the property, fired.

Inflation is now “transient” in the sense that after the “happy run” of consumer and investment spending ends in 2022, GDP, investment and productivity growth will fall back to rates inherent in the “long depression” – something that has been happening since the end of the millennium. This means that inflation will decrease. O Fed forecasts real GDP growth of just 2% through 2024 and 1,8% per year thereafter – a rate lower than the average of the past ten years. In the third quarter of 2021, US productivity growth fell for the quarter in 60 years, while the annual rate fell by 0,6%, the biggest drop since 1993, as employment grew faster than output.

Some optimists argue that there will be a boom in capital spending on new technologies, automation, etc., which will increase labor productivity. But the profitability of capital accumulation in all major economies remains depressed and at near historic levels despite the recovery in 2021.

As Brian Green put it in a recent post: “Demand-driven inflation is likely to have eased. It seems that, now that Covid funds have been depleted, US consumers are joining the rest of the world in the downturn as container ships continue to line up outside ports to load and unload. What remains are supply bottlenecks, as well as tactics to manipulate the system. Recurring inflation is evident. Both the US and the UK reported record or near-record producer prices. When recurrent inflation cannot be satisfied by demand, it is profit margins that suffer and that is what is happening now and will intensify in the new year”.

And the Omicron and Delta variants of COVID are affecting the production of goods and services. The latest December economic activity surveys (called PMIs) showed a significant slowdown in the pace of recovery from the pandemic crisis. UK and eurozone measures are now at nine-month lows.

Is the stagflation (low growth and high inflation) of the 1970s coming back? Well, stagnation seems much more likely than inflation; what happens to the latter will depend on factors beyond the control of central banks. That's why this hasn't been the kind of inflation that Jay Powell was hoping for.

*michael roberts is an economist. Author, among other books, of The Great Recession: A Marxist View.

Translation: Eleutério FS Prado.

Originally published on the website The next recession blog.

 

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