Inflation-oriented farce: high costs, arguable benefits


  • Opinion by Jomo Kwame Sundaram, Anis Chowdhury (Sydney and Kuala Lumpur)
  • Inter Press Service

IT disagreement
Heads of major central banks – such as the US Federal Reserve Bank (Fed), Bank of England (BoE) and the German Bundesbank – pledged to keep inflation at 2% shortly after New Zealand. While typically ‘medium term’, the high cost of IT is portrayed as necessary, but short. Worse, promised growth benefits have not materialized.

The International Monetary Fund (IMF) statutes have never approved a fixed inflation target. Article IV states that “each member shall: (i) strive to direct its economic and financial policies towards the goal of promoting orderly economic growth with reasonable price stability, taking into account its circumstances”.

This makes it clear that a lot depends on conditions and circumstances. The sensible priority would then be to maintain prosperity with “reasonable price stability”, and not commit itself at all costs to any universal IT. Yet many IMF officials promote the 2% target.

For him, “monetary policy must look beyond the core focus on low and stable inflation” to promote balanced and equitable growth, while minimizing negative spillovers to emerging economies.

One IMF chief economist even claimed that low inflation and economic progress was a “divine coincidence”, insisting that a 2% inflation target was too low. After the GFC, an IMF working paper called for a long-term inflation target of 4% for advanced countries.

A Bank of Canada working paper concluded, “the current state of economic research – both empirical and theoretical – provides little basis for believing in significant observable benefits of low inflation, such as an increase in real GDP growth”.

IT benefits?
Any objective consideration of actual IT experiences would have been rejected long ago. IT is clearly at odds with growth and equity, let alone the Sustainable Development Goals (SDGs). Four experiences from central banks offer valuable lessons about the likely consequences of IT.

The US Fed is by far the most important CB globally, while the BoE has been historically important. The Bundesbank was the most inflation-averse in the post-war era, while the RBNZ was the world’s IT pioneer.

Inflation in New Zealand averaged 9% in 1961-90, over 5.1% in the US and 8% in the UK. Still, the mighty Fed and the venerable BoE tried to match the minuscule RBNZ! Germany’s well-known inflation phobia is attributed to interwar ‘hyperinflation’ and its bloody aftermath. Inflation there averaged 3.4% over 1960-90, so even before IT.

None of them achieved sustained economic prosperity despite achieving inflation targets of 2% or less. Average GDP growth per capita declined sharply in the US, UK and Germany, while it increased negligibly in NZ (Table 1).

Prolonged declines in their growth rates followed declining investment (Table 2). IT proponents argue that high inflation creates uncertainty, decreasing investment, but lower inflation has clearly done worse.

As the investment rate declined in IT, productivity growth in the UK, Germany and NZ also declined (Table 3). While IT productivity growth has increased negligibly in the US, it has declined in all four economies (Figures 1-4). U.S. hourly production grew by just 1.4% after 2004, “half the pace in the three decades after World War II.”

Most advanced economies have experienced productivity slowdowns since the 1970s. With the European Central Bank’s strict IT framework, the eurozone also saw marked slowdowns in productivity growth over the period 1999-2019.

Slowing productivity growth often becomes the pretext for depressing real wages and working conditions, forcing workers to work longer hours to compensate for lost earnings. Productivity and growth slowdowns are seen as ‘secular stagnation’.

All this is attributed to inflation. But lowering inflation has not reversed this trend, which has accelerated since the GFC. Many explanations have been given, but the reasons for this failure remain unmentionable.

IT, low inflation, tax cuts and market reforms should improve economic performance. Weak investment and economic growth, driven by contracting macroeconomic policies, slowed US productivity growth.

likewise, The economist observed: “Declining demand reduced incentives to invest and innovate”. It attributed slowing productivity growth in the UK to cutbacks in investment in innovation due to, among other things, “austerity policies” and “severe reduction in credit”.

Concluding “undoubtedly, the costs were … enormous,” it estimated, “British GDP per person in 2019 would have been £6,700 ($8,380) higher than it turned out” if productivity growth hadn’t fallen further after the GFC.

It is increasingly recognized that the widespread “unconditional” commitment by the CBs to meet the 2% inflation target – in light of the current rise in inflation – is likely to exacerbate the slowdowns. This is likely to exacerbate the debt crisis in many developing countries.

The adverse socioeconomic effects of recessions are well documented. Policy-induced recessions – ostensibly to curb inflation – will amplify the effects of pandemic, war and sanctions.

Pragmatism, not dogma
Central bankers should not be dogmatic. Instead, pragmatic approaches are urgently needed to tackle the current inflation spikes. This is especially necessary when inflation worldwide is mainly due to supply shocks.

Western policymakers need to consider the negative spillover effects on developing countries, which are already on the brink of a debt crisis due to lengthy delays. Public debt – with higher costs for commercial loans – has risen since the GFC, Western ‘quantitative easing’ and Covid-19.

Almost all central bankers know that in the current circumstances it is almost impossible to achieve an inflation rate of 2%. Still, they maintain that not raising interest rates now will cause a lot of economic damage later on.

But such claims clearly have no theoretical or empirical basis. Therefore, it is recklessly dogmatic to enforce a 2% target by falsely claiming that doing nothing would be even more harmful.

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© Inter Press Service (2022) — All rights reservedOriginal source: Inter Press Service

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