Inflation paranoia threatens recovery
By Anis Chowdhury and
Jomo Kwame Sundaram
SYDNEY and KUALA
LUMPUR, Feb. 1, 2022 (IPS) –
Inflation hawks are winning the
day. The latest ‘beggar thyself’
race to raise interest rates has
begun. This ostensibly responds
to the spectre of runaway inflation,
supposedly retarding economic
growth and progress,
and thus threatening central
bank ‘credibility’.
Inflation fetish
The ‘one size fits all’ policy of
raising interest rates to contain
inflation is being touted again,
the world over. This will surely
kill national efforts to revive
economies reeling from COVID-
19 pandemic slowdowns.
Central banks in many
emerging market and developing
economies (EMDEs) – such
as Brazil, Russia and Mexico
– began raising policy interest
rates right after inflation
warning bells were set off after
mid-2021. Indonesia and South
Africa have since joined the
bandwagon.
International Monetary Fund
(IMF) Managing Director Kristalina
Georgieva has warned
that US interest rate rises would
“throw cold water” on global
recovery, especially hurting
struggling emerging markets.
An earlier IMF blog had urged
EMDEs to prepare for earlier
than expected US interest rate
hikes. The Fund has lowered its
growth projections as the inflation
bogey induces monetary
and fiscal tightening.
Inflation paranoia
Inflation hawks denounce
price increases, claiming
– without evidence – that it
impedes growth. Former World
Bank chief economist Michael
Bruno and William Easterly
refuted these popular, but false
prejudices.
Using 1962-1992 data for 127
countries, they found, “The ratio
of fervent beliefs to tangible evidence
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seems unusually high”.
They also found extremely high
inflation – over 40% yearly –
mainly due to very exceptional
circumstances, e.g., Nicaragua
after the Sandinista takeover.
Bruno and Easterly concluded
that inflation under 40% did
not tend to accelerate or worsen.
They concluded, “countries can
manage to live with moderate
– around 15–30 percent – inflation
for long periods”.
Bank economists Ross Levine,
Sara Zervos and David
Renelt confirmed a negative
inflation-growth relationship to
be exceptional, and due to a few
extreme cases.
Rudiger Dornbusch and
former IMF Deputy Managing
Director Stanley Fischer came
to similar conclusions. They
too found moderate inflation of
15–30% did not harm growth,
emphasizing “such inflations
can be reduced only at a substantial
short-term cost to
growth”.
Citing IMF research, Harry
Johnson also argued that while
very high inflation could be
harmful, there was no conclusive
empirical evidence of the
alleged inflation-stagnation
causal nexus.
Even monetarist guru Milton
Friedman acknowledged, “Historically,
all possible combinations
have occurred: inflation
with and without development,
no inflation with and without
development”.
Thus, the Fund and the Bank
have no sound bases for promoting
draconian policies to eliminate
inflation above, say 5%, by
citing a few exceptional cases
of very high, runaway inflation
and low growth.
Inflation misdiagnosed
Friedman’s sweeping generalization
that “inflation is
always and everywhere a monetary
phenomenon” ignored
other factors possibly contributing
to inflation.
Without careful consideration
of inflation’s causes, the
same old policy prescriptions
are likely to fail, but not without
causing much harm. Prices
tend to rise as demand outstrips
supply. This can also happen
when demand rises faster than
supply, or if demand does not
decline when supply falls.
The IMF attributes the current
inflationary surge to supply
chain woes, higher energy
prices and local wage pressures.
While demand has been boosted
by pandemic relief and recovery
measures, where existent, supply
shortages remain vulnerable
to disruptions.
Rising food costs are also
pushing up consumer prices.
Extreme weather events –
droughts, fires, floods, etc. –
have affected food output. More
commodity price speculation –
e.g., via indexed futures – has
also raised food prices.
Although wages have risen in
some sectors in some countries,
economy-wide wage-price spirals
are unlikely. Employment
suffered during the pandemic
while unionization is at historically
low levels.
Labour’s collective bargaining
powers have declined for
decades, especially with technological
change, casualization
and globalization lowering the
labour income share of GDP.
As the profit share of income
continues to rise, rising markups
and executive remuneration
also push up prices. With
more market monopoly powers,
price gouging has become more
widespread with the pandemic.
Understanding what causes
particular prices to rise is critical
for planning appropriate policy
responses. Although devoid
of actual diagnoses, inflation
hawks have no hesitation prescribing
their standard inflation
elixir – raising interest rates.
Raising interest rates may
help if inflation is mainly due to
easier credit fuelling demand.
But tighter credit is unlikely
to effectively address ‘supplyside’
inflation, which typically
requires targeted measures to
overcome bottlenecks.
Interest rates harm
Higher interest rates increase
borrowing costs, squeezing
investment and household
spending. This hits businesses,
hurting employment, incomes
and spending, and can result in
a vicious downward spiral.
Higher interest rates also
increase governments’ debt
burdens, forcing them to cut
spending on public services
including healthcare and education.
Incredibly, elevated
interest rates – harming investments,
jobs, earnings and social
protection – supposedly benefits
the public!
The adverse spill-over impacts
of rising interest rates are also
considerable. Raising rates in
major advanced economies
weaken EMDE capital inflows,
currencies, fiscal positions and
financial stability, especially as
sovereign debt has ballooned
over the last two years.
Indeed, the interest rate is a
blunt weapon against inflation.
How can raising interest rates
curb food or oil price increases?
While supply blockages persist,
essential consumer prices will
rise, even with high interest
rates.
Higher interest rates may
even aggravate inflation as businesses
cut investment spending.
Thus, supply bottlenecks,
especially of essential goods, are
likely to be more severe, pushing
up their prices.
Most people are indebted,
with the poor often borrowing
to smoothen consumption.
Thus, the poor are hurt in many
ways: losing jobs and earnings,
coping with less social protection,
and having to borrow at
higher interest rates.
Hence, the standard medicine
of higher interest rates
has massive social costs. Meanwhile,
the principal beneficiaries
of using higher interest
rates to lower inflation are rich
net creditors and financial asset
owners.
Toxic prescription
Premature reversal of expansionary
fiscal policy has been
largely due to debt hawks’ successful
fear mongering. Thus,
debt paranoia nipped in the
bud the ‘green shoots’ of robust
recovery following the 2008-
2009 global financial crisis.
In the early 1980s, inflation
paranoia led to interest rate
spikes, triggering debt crises,
stagnation and lost decades in
much of the world, especially
developing countries. Now,
inflation hawks are poised to
derail global recovery, stop adequate
climate action and otherwise
undermine sustainable
development.
Policymakers the world over,
but especially in developing
countries, must reject the inflation
hawks’ paranoid screeches.
Instead, they must identify and
address the sources, causes and
nature of the inflation actually
faced. And then, take appropriate
measures to prevent inflation
accelerating to harmful
levels.
There are a host of alternative
policy measures available to policymakers.
They must reject the
lie that they have no choice but
to raise interest rates – widely
recognized as a blunt weapon,
with deadly ‘externalities’.
While all available policy
options may involve trade-offs,
policymakers must seek and
achieve socially optimal results.
This requires robust, resilient,
green and inclusive recoveries –
not fighting quixotic windmills
of the paranoid mind.
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