Can a little chicken be a good thing?
Money illusion works. Current and former central bank economists appear to be wringing their collective necks on the question: Is inflation here to stay?
The nascent consensus seems to be a Yes; inflation arose from ‘supply bottlenecks’ as economies dealt with the CoViD pandemic, although these bottlenecks are only partly a replay of the 1970s era of cost-push inflation.
The thing that seals the deal today is Russian control of energy supply and its price.
In this train of cost-push thought, central banks are powerless – they have no real resources to sell to tamp down inflation. If they adjust the monetary policy lever (by raising their official interest rates), they risk recession and unemployment all around.
Their strategy seems to be one of ‘benign exasperation’ – one of going down on their knees, and praying for some kind of divine intervention that wipes out inflation, while making tiny noises about raising interest rates “slowly.”
Nuts! Today’s central bankers don’t have the guts of a Paul Volcker, that lone sheriff at the US monetary corral who said that enough was enough. If a recession is needed to kill inflation, he would chomp on his cigar, and say “Do it.”
Because of Volcker, interest rates soared in the early 1980s, and profligate countries who borrowed to pay for high-priced OPEC oil suffered through external debt crises for a decade or so, but the world survived.
All the pain was eventually forgotten, inflation ebbed to 2 percent levels, and this allowed central banks to embrace a new religion called Inflation Targeting.
From a cynical perspective, the new religion was just a cover story for interest rates that were low enough to keep two sets of interest groups very happy – holders of stocks on one hand, and sellers of bonds on the other.
Life was sweet, and not even the shock of 2008 would make enough people cry. Never mind that central banks’ macroeconomic models couldn’t predict financial crises (we knew that from reading economic history).
A few banks suffered, but so what? The solution was to demand additional capital, which proved easy.
Modest or moderate inflation, targeted at that, was then accepted as the handmaiden of global economic prosperity. Self-congratulation was in vogue. The Great Moderation was the label for the prosperity seen from the mid-1980s to 2007. The financial crisis of 2008 interrupted the party, but only briefly. I would dare to say that the Great Moderation actually resumed in 2010, ending only in 2019 with the virus from China.
Still, it was an uneasy moderation; there was a foreboding that bad things lay beneath the surface. The danger of asset bubbles didn’t disappear.
What went wrong? Nothing. We don’t want Volcker giving us lectures on responsible monetary policy. We don’t want economists of the Austrian school reminding us that interest rates at or below the inflation rate are a recipe for a business boom-then-bust scenario, as well as for generating asset bubbles.
We don’t want to see if China can contain the imbalances built up from over-speculation in real estate, and from dealing with CoViD. We think the world will somehow survive Putin’s little war near his backyard. All is well.
Even better, we can ask about what went right. We learned that inflation has a mind of its own. Before the Great Moderation, we were taught that unemployment was inflation’s malevolent twin. Kill inflation, you get unemployment. Kill unemployment, get inflation.
That trade-off had a name — the Phillips Curve. With the Great Moderation, the Curve was pronounced dead, or if undead, a zombie.
Because of central banks’ success with inflation targeting, we easily had low interest rates (at full employment), and little inflation. Why so little?
It was, and is because prices are a matter of ‘groupthink’ between firms and households as they do a bargain/rain dance on prices and wages.
A virtuous ‘After you, Alphonse’ circle means that if both sides “moderated their greed,” a low inflation equilibrium results.
We had the equivalent of having and finding an economic Holy Grail (in the sense of full employment and low inflation).
But we didn’t foresee a virus pandemic coinciding with a war in Ukraine. The Grail vanished.
There’s reason, however, to think that the Grail may reappear once we control the global pandemic, stumble into an uneasy peace in Europe, and (more importantly), if we can tame the business cycle.
In the meantime, inflation is here to stay. For how long, no one can honestly say.
There are arguments out there calling for central banks to reverse their easy monetary policy “slowly.”
One former official of the Bangko Sentral ng Pilipinas (our central bank) supports a proposal for “symbolic tiny increases in nominal interest rates” (Diwa Guinigundo, in an op ed at Business World, April 8, 2022).
Two former officials of the International Monetary Fund echo this concern with financial fragility; they see “a narrow path between adequate monetary restraint, and risking a financial crisis” (Leslie Lipschitz and Josh Felman, in an op ed at Barrons, Jan. 23, 2022). They do not seem to favor the Volcker do-si-do of raising nominal interest rates to levels above the expected rate of inflation.
Are they dreaming? Yet, they all appear to concede that too little too late portends a disaster. This proves the propensity of economists to hedge their pronouncements.
What can we conclude? Inflation came and went in the 1970s and 1980s. In the near future, it will likely do the same. But it will be painful, particularly in the Philippines where wages take a while to catch up with prices.
Is there a way out? Perhaps. Will both households and firms behave with patience? Will central banks do the sane monetary policy?
If the answers are in the negative, somewhat optimistic prognoses are out of the question, and we would then enter a territory of ‘high everything’ – high inflation, (eventually) high interest rates, high uncertainty on the vicissitudes of the business cycle, and high volatility in the stock and bond markets.
The Titanic is sinking; where are the lifeboats?
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Author’s email: oroncesval4@gmail.com; Twitter: @ORoncesvalles
