Quantitative Easing

Why inflation fears are exaggerated and misplaced


Bank of England chief economist Andy Haldane added his voice to the growing chorus of warnings about the looming threat of inflation. Citing the risk of what he called a “expensive-salary”Spiraling as demand recovers from the first shock of Covid-19, Haldane and inflation hawks such as former US Treasury Secretary Lawrence Summers quickly suggested that current levels of government spending across the world will have to be reduced, and the “Lose money” policy of vast quantitative easing (QE) and reduced low interest rates. Haldane, who will be leaving the bank later this month, believes the wage-price spiral is a weak descendant of the legendary “wage-price” spiral of the 1970s, in which rising prices trigger demands for higher wages, in turn pushing up prices, etc.

These are not the first inflation warnings from central banks or those linked to them. The Bank for International Settlements, the “central bank of central banks”, was already signaling inflation risks in its 2020 Annual Report, published last summer at the height of the first wave of Covid-19. “[P]forward-looking, “he suggested that something like the economic situation in the post-war West could reappear in the wake of the pandemic, with ever-larger government, globalization” forced into a major setback “and” labor and business “much thus more able to set their own prices. Much like the post-World War II period, we would expect somewhat higher inflation – but also, and most importantly, to higher wages.

Some of this may already be happening. Trade has become a smaller part of the global economy in the decade since the 2008 crash, and of course the pandemic has hammered international trade in services such as tourism and aviation. Governments around the world were already becoming more active in the economy after 2008, increasing their spending relative to GDP and reverting to forms of industrial strategy. Covid-19 appears to have accelerated both trends, and the pre-Covid world will not be returning entirely. The UK Office for Budget Responsibility, for example, forecasts public spending as a percentage of GDP be the highest since the early 1980s, even after all exceptional expenses related to Covid have been canceled.

But as I have argued before, the impact of the virus appears likely to increase labor costs and difficulties in the longer term. And these additional costs and difficulties create the potential for improving the bargaining position of workers. If, for example, work can be removed more easily due to health risks and if employers lose some of their control over working conditions due to the need for various forms of protection at work, then all other things being equal, the work will be in a stronger position.

[see also: Inflation scare stories must not stop workers getting the pay rises they deserve]

As retail opens up and people come out to spend, we are already seeing how restaurants and pubs, faced with a tight supply of labor, offer higher salaries. Requests for protection at work have called strikes, and union membership in Britain last year grew at its fastest pace since the late 1970s. If, as epidemiologists predict, Covid remains a risk for the foreseeable future, these restrictions on labor supply will not be fully lifted: some additional costs and difficulties will remain. There is likely to be a significant churn rate in the labor market, with McKinsey predicts 2.7 million ‘professional transitions’ over the next decade, as employers seek to reduce their reliance on labor in industries such as retail, primarily through automation. But because the possibilities for automation are so industry-specific, it won’t necessarily translate into a widespread weakening of the workforce as mass unemployment usually does.

Coupled with “the great demographic reversal” identified by Charles Goodhart and Manoj Pradhan in their recent book, as the future global labor supply grows much more slowly than over the past 40 years, the stage is ripe for the economy to balance in favor of those who work. Wage increases, after decades of stagnant real wages in the developed world, would not be a bad thing. Moderate inflation, below nominal wage increases, and occurring after decades of deflationary pressure, would not be a bad thing either.

But higher inflation would not be the result of too much money in the economy, nor of a government ‘spending too much’. The increase in inflation would be the product not of monetary factors, but of real factors in the first place – such as longer-term increases in labor costs – making taxes and subsidies mechanisms of change. more effective price controls. The government’s worst possible response to this change in environment would be for central banks to tighten monetary policy – reversing QE and raising interest rates – and for the government to impose significant spending cuts.

If inflation reappears as a result of long-term increases in costs, rather than increases in the effective money supply, there is little monetary policy can do to affect it – and monetary tightening risks driving downward trends. Heavily indebted businesses and households go bankrupt as interest rates rise and loans cannot be renewed. Meanwhile, if public spending is to be increased due to rising costs, for example to finance the longer-term burden Covid will place on healthcare systems, the spending cuts will damage public services while (like us saw it with a decade of austerity) redistributing resources in exactly the wrong direction – up the income ladder. The only plausible way for either strategy to influence inflation is to weaken the ability of those who work to negotiate higher wages.

Productivity growth could ease the tension by creating more room for wage increases without squeezing profits, but productivity has stagnated in the developed world for a decade, with little sign of recovery before the pandemic. Rather, demands for tighter money and reduced spending should be seen for what they are: a preventive strike against workers.



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