Calls, even screams, to fight inflation above all else are getting shriller. Thankfully, even The Economist (5 Feb. 2022) reminds all, Fighting inflation could put the world in a slump.

No inflation consensus
International Monetary Fund (IMF) Managing Director Kristalina Georgieva doubts the world faces a runaway inflation threat. She urges policymakers to carefully calibrate fiscal and monetary policies, with more “specificity”, as not ‘one size fits all’.

Anis Chowdhury

Instead, like Georgieva, he advocates a more nuanced approach, reasoning, “As the pandemic recedes and the level and composition of global demand and supply normalise, these inflationary pressures should subside”.

US inflation phobia
Inflation hawk Larry Summers – Clinton’s last Treasury Secretary and Director of the National Economic Council during Obama’s first two years – claims it is “wishful thinking” that current inflationary pressures will subside.

He insists, “The painful lesson of the 1960s, 1970s and the 1982 recession is that excessive demand stimulus leads not just to inflation, but to stagflation and ultimately recession, as inflation must eventually be brought under control”. But Summers’ economic history is partial, tendentious and misleading.

Draconian policy prescriptions supposedly inflict ‘short-term pain for long-term gain’, but care little for their ramifications. Summers has nothing to say about how the early 1980s’ interest rate hikes pushed nations into default, triggering debt crises, and over a decade of stagnation in much of the global South.

Most governments can do little to tackle rising commodity, especially fuel and food prices. Conventional monetary tightening reduces overall inflation, typically by inflicting much unemployment, without affecting international sources of inflation.

Jomo Kwame Sundaram

First, recent wages growth is not due to workers’ collective bargaining, as in the 1960s. Or ‘wage-indexation’, linking wage growth to inflation during the 1970s.

Workers’ bargaining power has declined greatly since the 1980s, with labour market deregulation increasing casualization.

Meanwhile, foreign direct investment has accelerated offshoring, while technological changes have reduced labour needs. Many have changed to self-employment, informal work and other ‘off-the-books labour’. By 2020, there were more than two billion in informal work, mostly in developing countries.

The pandemic has greatly increased ‘gig work’, especially in higher income countries. More piecework remuneration and illusions of independence barely compensate for less bargaining power, and greater labour, work and income insecurity. Working from home increases unpaid overtime work as ‘wage theft’ becomes more widespread.

Second, apparent wage rises may be a statistical anomaly. An estimated third of the total US non-farm workforce, many low-paid – quit their jobs in 2021 for health and safety reasons while better paid workers remained in employment.

IMF research also found labour supply declined in the US and the UK as older workers and mothers with young children quit due to pandemic related challenges. This changing composition of employment has raised the average wage.

Consider a job market with three workers – A, B and C, with hourly wages of $10, $20 and $60 respectively. The average hourly wage is $30. If worker A quits, the average hourly wage – for workers B and C – will be $40. This raises the average hourly wage by $10 – not due to wage growth, but the changing workforce composition.

The higher reported US wages reflect the one-time impact of increased minimum pay, especially when paid by major employers with a nationwide presence such as Target, Southwest Airlines, CVS Health and Walgreens.

Bleak prospects
The IMF’s October 2021 World Economic Outlook saw bleak prospects for low-skilled and young workers. This seems consistent with why low paid workers are reluctant to work for a pittance at great personal risk to themselves.

Many younger workers face special difficulties, e.g., parents of young children due to inadequate childcare facilities and pandemic school disruptions. The mismatch between available jobs and what people want has also grown.

Current inflationary pressure resembles the post-World War Two situation, with pent-up demand for consumer goods unleashed before war-disrupted supplies were restored. Inflation reached nearly 20% in 1947 before collapsing.

Current consumption demand still faces supply chain disruptions due to the pandemic. But such situations are very unlike the episodes Summers cites to make his alarmist case for prioritizing inflation.

Conventional anti-inflationary policies – e.g., fiscal austerity, raising interest rates and credit tightening – are not only inappropriate for dealing with current inflationary pressures, but can be very harmful – as the IMF chief warns.

Understanding inflation
The pandemic has triggered large price increases – notably for food, clothing, fuel and communications. The mismatch between labour supply and demand in some sectors has also become more acute.

Meanwhile, US government data show US non-financial corporations raked in their largest profits ever since 1950 in the second half of 2021 despite rising labour costs. But Summers denies that monopolistic corporate behaviour has contributed to price increases.

Overall corporate profits rose 37% from the previous year while employee compensation only increased 12%, despite “the second year of a pandemic which began by wiping out 20 million jobs”.

US Senator Sherrod Brown (Democrat-Ohio) has asserted that “prices are high because corporations are raising them – so they can keep paying themselves with ever-larger executive bonuses and stock buybacks”.

Rising house prices and accommodation rentals are also raising living costs. Following the 2008-2009 global financial crisis (GFC), governments ill-advisedly abandoned fiscal recovery efforts early. Unconventional monetary policies became the main policy tool since.

This has encouraged real estate and financial asset speculation, instead of investing in productive capacity. Fiscal austerity and continued reliance on market solutions also deter government actions to address key supply chain bottlenecks.

Lack of effective coordination between fiscal and monetary authorities – e.g., in responding to the pandemic – has exacerbated such situations. Instead, commodity and real estate speculation has been much enabled.

Such perverse incentives have undermined needed investments in information and communications technology (ICT), renewable energy, sustainable agriculture, healthcare and education. Businesses have even paid out dividends and bonuses with COVID relief funds. Thus, billionaires got billions more.

Nuance and specificity
Effective coordination between fiscal and monetary authorities is vital for a nuanced approach to ensure sustainable, inclusive and resilient recovery. Fiscal-monetary policy coordination is also needed for a range of long-overdue reforms to address structural factors exacerbating inflationary tendencies and pressures.

But earlier reforms to ensure central bank independence and strict ‘fiscal rules’ in favour of market solutions have undermined government fiscal and monetary capacities to act effectively. Thus, such policies and related ones – e.g., inflation-targeting – must be irreversibly consigned to the policy garbage bin.

Knee-jerk responses to fear mongering by inflation hawks will derail global recovery which the IMF deems “disruptive”. The Fund is also concerned about “divergent” recoveries between rich and poor nations.

Instead of the new Cold War preference for economic sanctions at the slightest pretext, much better and more sustained international cooperation and policy coordination are needed. They must address global supply chain disruptions, stabilize international commodity prices and minimize harmful policy spill overs.

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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’.

Anis Chowdhury

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 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.

Jomo Kwame Sundaram

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 mark-ups 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 ‘supply-side’ 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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The bogey of inflation has been revived. Dubious pre-pandemic economic progress, fiscal constraints and vaccine apartheid were bad enough. Now, ostensibly anti-inflationary measures also threaten recovery and sustainable development.

The International Monetary Fund (IMF) has revised downwards its latest global growth forecast. Its latest World Economic Outlook (WEO) warns of a “dangerous divergence” between richer and poorer countries. This has been exacerbated by, but has also worsened national fiscal disparities and the ‘great vaccine divide’.

Anis Chowdhury

But over 70%, or 152 of 209 economists polled believe rising inflation worldwide is due to temporary supply chain disruptions. Heads of major central banks – such as the US Federal Reserve, Bank of England and European Central Bank – concur.

Although the IMF agrees, it also urges policymakers to “be on the lookout and be prepared to act, especially if…prolonged supply disruptions, rising commodity and housing prices, permanent and unfunded fiscal commitments, a de-anchoring of expectations, combined with mismeasurement of output gaps [materialise]”.

The IMF’s October 2021 Fiscal Monitor urges governments to take all steps necessary to regain capital markets’ and lenders’ confidence, including by reducing budget deficits. But it also warns against ‘self-defeating’, premature phasing-out of needed recovery measures. Thus, the ‘two-handed’ IMF economists offer contradictory policy guidance.

Wrong diagnosis
But inflation is unlikely to persist. First, labour market deregulation since the 1980s has long eroded workers’ bargaining power. Hence, workers are now more worried about job security, badly eroded in recent decades.

Second, ‘decent’ job creation remains weak in most rich countries after decades of ‘off-shoring’ and labour-saving innovation. Unsurprisingly then, labour shares of national income have been falling since the mid-1970s.

Jomo Kwame Sundaram

The WEO notes private investment fell in 2021’s second quarter, with several new uncertainties responsible. Slower investment and growth also mean less tax revenue and higher debt-GDP ratios. Cutting spending will only make things worse.

Correct diagnosis should be the basis for choice of medication. Contrary to monetarist faith, inflation is not only due to excess money supply. But if supplies are blocked – e.g., due to disasters, conflicts, curfews or transport restrictions – demand easily becomes ‘excessive’.

Inflation is often also due to big suppliers abusing their market power, with powerful firms raising prices with higher ‘mark-ups’. Privatization and deregulation over the last four decades have strengthened these monopolies or oligopolies.

Blunt instrument
The WEO seems more concerned with inflation than employment as financial markets demand monetary tightening, interest rate hikes and fiscal austerity. Bloomberg has urged emerging economies to “brace for rate hikes”, with Mexico, Brazil, Peru, Russia and others obliging, as The Economist anticipated.

The interest rate is a blunt tool. Inflation is reduced by raising interest rates, cutting growth and increasing unemployment – “tough medicine” indeed. Hawks emphasize how inflation erodes the poor’s purchasing power, but deny their prescriptions do worse.

One must also wonder how interest rate hikes are supposed to address actual problems. For example, in September 2021, global food prices shot up nearly 33% year-on-year, due to extreme weather and pandemic restrictions. Higher rates also certainly could not help when a severe drought hit hydroelectric power generation in Brazil.

Higher interest rates squeeze both private and government spending. Thus, rate hikes will likely trigger a vicious circle of further rate increases and general austerity, slowing recovery and raising debt-GDP ratios.

Raising interest rates in rich countries will also see more capital flight from developing countries and exchange rate depreciations. Already handicapped by vaccine inequity and constrained fiscal space, worsened by modest debt relief and pandemic support from rich countries, raising interest rates will set them further back.

Debt misconstrued
Rising debt levels have understandably been an on-going concern. In 2019, the World Bank warned that post-2008 global financial crisis (GFC) indebtedness was dangerous, noting all previous debt waves had ended in crises.

With the pandemic, fears have been “looming” again of “catastrophic” debt crises in developing countries. As if governments had much choice, the Wall Street Journal warned, “Governments world-wide gorge on record debt, testing new limits”.

The IMF’s October Fiscal Monitor acknowledges, “there is no magic number for the debt target. Macroeconomic theory does not prescribe a specific debt target; nor is there a clear threshold above which debt might become particularly harmful to economic growth”. This confirms earlier IMF and World Bank findings suggesting exaggeration of debt constraints.

Rather, the focus should be on “the likely growth effects of the level, composition and efficiency of public spending and taxation”. Instead of fixating on overall debt levels, its composition – domestic vs external, public vs publicly guaranteed – deserves more attention.

In fact, debt-financed infrastructure, education, skill development and retraining programmes all enhance growth. IMF research found such infrastructure investment had large growth effects without even raising the debt-GDP ratio.

Deep-seated challenges
The predictable recommendation is ‘belt-tightening’ – via ‘austerity’ and ‘higher interest rates’ – bringing even more economic contraction. Typical structural reform prescriptions – e.g., more labour market liberalization, deregulation, privatization and tax cuts – only make things worse, while regressive tax cuts rarely generate promised growth.

Financialization in recent decades has encouraged more speculation, share buybacks, real property, mergers and acquisitions. Consequently, the real economy has suffered, with inflation rising as productivity growth falters.

But inflation was kept in check by cheap imports and cheaper labour, even as profit margins and executive salaries rose. But neoliberals have not hesitated to claim credit for taming inflation during the Great Moderation via fiscal austerity, debt ceilings and inflation targeting.

Despite fiscal austerity, debt has risen, especially since the GFC. Slower growth has also meant less revenue, further reducing fiscal space. Public investment cuts – particularly for services, infrastructure, research and development – have also hurt productivity growth.

Build forward, not backwards
Every economic crisis is different in its own way. The COVID-19 recession involves both supply and demand shocks. Output has fallen due to lockdowns and value chain disruptions. Demand has also declined with lower incomes, less spending, more jobs lost and greater uncertainty.

When provided, relief measures have sustained some demand. Pandemic restrictions have accelerated digitalization, but other changes are also needed. Reforms must build on COVID-19 transformations for a better future , e.g., by promoting job-intensive green investments, worker reskilling and retraining.

The COVID recession thus offers an unexpected opportunity to ‘build forward better’ to address deep-seated problems to build a better world. This must necessarily involve shedding biased and dysfunctional arrangements, managing markets, guiding private investments, workforce retraining and investing in education, health and social protection.

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