Neoliberal response to inflation still fails

Civil servants, like many other groups of workers have been striking in response to high inflation (Picture: Guy Smallman)

For the past 18 months, the dominant economic policy issue in the advanced capitalist states has been how to reverse the sharp increase in inflation. The orthodox neoliberal response has been pursued rigorously by the central banks. They have increased interest rates with the aim of slowing their economies down.

This response is sometimes justified by something called the Phillips Curve. This is supposed to show that inflation and unemployment are inversely related. 

If it is correct, the way to reduce the rate of inflation is to force unemployment up. Higher interest rates push firms into bankruptcy. Workers lose their jobs. Those still employed feel less confident to defend their real wages and inflation slows.

But this picture doesn’t fit the present situation. Jay Powell, chair of the most powerful central bank, the US Federal Reserve Board, admitted last month, “I do not think that wages are the principal driver of inflation.” 

Last week the Fed didn’t raise rates again, though the European Central Bank did, and the Bank of England (BoE) was expected to do so this Thursday.

The Financial Times Unhedged column explained, “There’s a plain enough empirical reason for this shift in attitude, in the past year headline inflation has halved while unemployment has stayed very low. The Phillips curve … hasn’t applied recently.”  Asked on Twitter “has it ever?” the co-author of this article, Robert Armstrong replied, “To a first approximation, no.”

We see a symptom of the crisis of the neoliberal ideology that has been dominant since the 1980s. Another sign of this crisis is the attention that the arguments of Isabella Weber, a young German economist working in the United States, have attracted. Much of this has been hostile.

When she first suggested in the Guardian newspaper that a better way of handling inflation was to use the kind of price controls introduced towards the end of the Second World War, she was denounced as “stupid”. A recent profile in the New Yorker magazine provoked a renewed outburst, no doubt motivated sometimes by professional envy and sexism.

Weber stuck to her guns. She and Evan Wasner have produced a compelling paper on “sellers’ inflation”. They draw on the work of the eccentric Marxist Michał Kalecki and post-Keynesian economists such as Nicholas Kaldor as well as empirical data. 

They argue that in economies dominated by big firms, these firms will react collectively to sudden price surges by defending their profits and passing on the increases.

The kind of disruptions the world economy has suffered recently—the supply-chain bottlenecks caused by the pandemic, growing competition for gas and oil, and the Ukraine War—make it easier for big firms to raise prices. Supply shortages mean that it’s hard for any of them to undercut the others. 

Workers striking for higher wages don’t start the inflation but are reacting, in a desperate effort to catch up. Weber and Wasner point to the signs that the present inflationary bout has peaked. But they warn, “We are living in times of overlapping emergencies. The pandemic is not over, climate change is a reality and geopolitical tensions are mounting. It is likely that there will be more shocks to come.” 

Indeed, climate change isn’t so much a “shock” as a continuing source of growing pressure as, for example, heat waves wilt crops and push up food prices.

And some economies are more vulnerable than others. The interest rates on gilts—British government bonds—are at their highest level since 2008. Money markets are betting that the BoE will have to carry on increasing interest rates for a while. 

BoE governor Andrew Bailey still believes in the Phillips Curve and is targeting wages after average earnings grew at an annual rate of 7.2 percent between February and April.

This attack from Bailey increases the chances of a recession next year. Meanwhile, higher interest rates are very bad news for anyone trying to take out a mortgage or renegotiate their fixed-rate deal when it expires. 

The Resolution Foundation estimates British households that come to the end of fixed-rate mortgage deals next year face an average £2,900 increase in annual payments. Rishi Sunak may soon discover he misses Boris Johnson.