Don’t call it inflation

Photo by Karolina Grabowska on

The media have been full of talk of so-called inflation, because the price of some commodities has risen sharply, due to the war in Ukraine, floods in eastern Australia and continuing disruption of supply lines by Covid. The Reserve Bank has made its predictable, reflex response by increasing interest rates – which is the only thing it can control anyway.

A rise in some prices is not necessarily inflation. If it is not, then a different response is required. Despite what many commentators are saying, the current rises in prices of energy and other things are not unprecedented. A similar thing happened in the 1970s too, and was misinterpreted then also.

Inflation is when an increase in the supply of money outruns the increase in the supply of goods and services. The causes of inflation can be several.

If the banks decide to double the amount of money in circulation, then the price of everything, including your wages, might double, because we all have more money to spend. But if the price doubles and our money doubles nothing has changed: we can still buy the same things for the same proportion of our income.

Except – financial assets and liabilities. Things like your savings account, your mortgage, many financial contracts used by business, and so on. Your savings will have lost half their value, in terms of what they can buy. Your mortgage will have reduced by half relative to your monetary income, so you’ll be happy about that and your bank will not.

So what can cause inflation? Some commentators make distinctions between different causes, with names like wage-push inflation and demand-pull inflation. One cause of inflation can be a wage-price spiral. Workers get wage rises, then bosses increase prices to cover the higher wages bill, then workers demand another wage rise, and so on.

Many economists seem to harbour a deep fear of a wage-price spiral, which they blame on labour unions interfering with the market (of people’s labour). But it takes two to tango, and the bosses bear equal blame for protecting their profits, even if they are high.

The price of natural gas has risen because Russia is limiting gas exports to the rest of Europe because of the Ukraine war. Higher gas prices increase the price of many other things.
Should this be called inflation? It is not an arbitrary increase in the money supply relative to the supply of goods and services. It is an increase in the effort we must expend to do the things we did before – make things, heat the house, drive a truck. You might call it price-push inflation, but that tends to disguise what is happening, which in turn leads to the wrong response. I would rather just call it a real increase in the cost of living.

Instead what has happened is that the price increases have been labelled inflation, mainstream economic managers and commentators agree inflation is bad and must be ‘tamed’, so the Reserve Bank has stepped in and raised interest rates, to ‘tame’ inflation.
The less benighted commentators, and many social welfare advocates, point out that raising interest rates simply further penalises the battlers with big mortgages or big rents, who were already struggling with bigger heating bills. It also risks a cascade of mortgage defaults, which could endanger the banks, and could bring on a recession. That seems like a strange way to address the problem.

If instead we say that the cost of living has just gone up, we might decide that everyone needs to make do with a bit less. We might decide that the wealthy are fine to look after themselves but the struggling battlers could use a bit of help. We might increase welfare payments, unemployment benefits (remember those?) and the minimum wage. We might close a few gaping tax loopholes to cover the cost.

Instead, the new Labor government has done basically nothing, leaving the Reserve Bank to its usual pavlovian response of raising interest rates. Why would it do that? Why is inflation bad? Well, because inflation is bad for the financial sector, which deals in ‘assets’ whose value is specified in dollars. Inflation devalues dollars, and therefore reduces the wealth of the financial sector relative to the real, productive economy.

Basically, the Reserve Bank protects its mates in the rest of the financial sector – the other banks and so on. Why does the Labor government go along with this? Because Labor stopped being a labour party in 1983, when it adopted and implemented the neoliberal agenda. Greens leader Adam Bandt is pretty accurate to say Labor is centre-right.

If you want a government that looks after the battlers and the rest of us, instead of the financial sector and the squillionaires, you’d better vote for the Greens. No I’m not a Greens member, but I think they are probably closer to Menzies’ version of postwar democratic socialism than modern Labor. It was a time of rapidly increasing prosperity too, widely shared because of strong unions. No, I’m not a socialist either.

If you want economic management that works for most of us, you need to advocate for an understanding of economics that bears some useful relation to real economies, which much of mainstream economics does not.

One thought on “Don’t call it inflation

  1. The Australian Energy Regulator proposes increasing the price of electricity by increasing the Rate of Return on regulated assets to “encourage” institutional investors to invest. This applies to equity and loans. It transfers income from consumers to the financial system and will magnify the increase in the cost of living for consumers. Even more galling is that consumers cannot invest in regulated assets. This is something that governments can fix with a stroke of a pen. Require Regulated assets Rate of Returns to drop to contain inflation, and allow consumers to invest before institutional investors. We think – but don’t know – that regulated assets in the energy sector are mainly owned by Private Equity. Why should we give extra to Private Equity, which specialises in finding ways to reduce taxes? Halve the Rate of Return and allow Consumers to invest; inflation will take a big hit, government revenues will increase, and the cost of living will drop.

    Liked by 1 person

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