Fact: inflation around the world is on the rise.
And as predicted, so are the calls on central banks to quickly intervene in an attempt to wrestle inflation back to some agreed-upon target level. Indeed, there exist among mainstream economists a quasi-unanimity that this is the proper policy route to follow: several increases in the rate of interest should eventually have an impact on those interest-sensitive components of aggregate demand to finally slow down economic activity in the hope that inflation will somehow float back to its target of, say, two per cent, at a minimal cost to society as a whole.
But heterodox economists know the rest of the story all too well: interest rates won't rise once or twice, but multiple times as central banks find themselves on the quest of what I called the Holy Grail: the search of that natural or neutral rate of interest, said to be up to 2.75% in both Canada, and the United States. This means up to possible 10 increases in interest rates. In this respect, central banks will never give up on the notion that somehow inflation is somehow related to monetary policy, and stand ready to increase rates as high as they need to be, as only monetary policy is able to bring inflation down to target.
While this is certainly a correct interpretation of pre-crises monetary policy, does it still stand post-crises? There is some evidence that perhaps central banks have softened their inflation zeal, by adopting dual mandates, flexible inflation targeting, or acting as if they already had. Is this a softer side of monetary policy?
I don't buy it. Inflation has always been considered public enemy No. 1, as it diminishes the value of Wall Street wealth. For that reason alone, central banks, who depend on the approval of Wall Street for their legitimacy, will never let this group down. So while it may begin with a few innocuous increases in interest rates, as inflation stubbornly won't come down, rate increases will continue … well … increasing. It is pre-crises monetary policy post-crises.
And the harm is now predictable. In fact, a recent report by Blackrock suggests that since current inflation is mostly the result of supply-side bottlenecks, not demand, attempts at bringing inflation down to 2% via interest rates would be costly for the economy and translate into unemployment of more than 10%.
Inflation and monetary policy are indeed linked, but not for the reasons given by the mainstream, but because both are rooted in conflict.
Fact 1: While inflation does lower the value of wealth, it also reduces the value of debt, ceteris paribus, mainly carried by workers. So inflation, itself the result of conflict, is rooted in conflict as to its causes as its consequences. While inflation does translate in lower purchasing power, workers lose far more from fighting inflation that they do from inflation itself.
Fact 2: As central banks insist on using monetary policy to lower inflation, it does so on the backs of workers, as repeated increases in rates may eventually collapse the economy, as stated above. Somehow, it is not ok to have inflation at, say, 7%, but it is ok to have unemployment at 10%? As a result, workers' income will be deeply affected.
Fact 3: As rates increase, it redistributes income from workers to rentier and bond holds.
In the end, we must be careful in using monetary policy to fight inflation. At the root of this debate, we must ask, 'what are we trying to prevent', and whether there are other means than monetary policy to achieve this.
If it is inflation we are trying to prevent, then we must ask is how much inflation is too much? Second, what are the causes of inflation? If the causes are not coming from the demand side, then using monetary policy, which impacts the demand side of the economy, may end up doing much more harm than good.
It is time for monetary policy to help workers, to help with a better distribution of income, and to help with achieving full employment. This requires a deep rethink of how monetary policy works, and whether it is the best tool with which to build back better, fairer and greener.
Copyright: Louis-Philippe Rochon
Full Professor of Economics, Canada
@Lprochon (Twitter user page).
March 9, 2022