The alarm bells about inflation are ringing ever more shrilly across the world economy. Huw Pill, the new chief economist of the Bank of England, predicts that the official British inflation rate will hit five percent early next year.
In the United States the annual rate of core inflation reached four percent in September, the highest it’s been in almost 25 years. Why is inflation rising?
The orthodox explanation is based on the famous statement by one of the two ideological godfathers of neoliberalism, Milton Friedman, that “inflation is always and everywhere a monetary phenomenon.” He argued that if the money supply rises faster than production, demand will increase more than the supply of goods and services, pulling up prices.
Faced with the pandemic, states followed Maynard Keynes, who advocated intervention in the economy, rather than Friedman. Central banks hugely boosted the money supply.
They bought up financial assets as a way of pumping money into markets that froze in March 2020. Meanwhile, governments in advanced economies massively increased their spending to fill the gap left by the collapse of private demand.
To a large extent, they financed this by extra borrowing. In the US and Britain, the Treasury bonds governments sold to borrow were bought mainly by the central banks. This modern equivalent of printing money was used to keep economies afloat. As economic historian Adam Tooze put it, “budget constraints don’t seem to exist—money is a mere technicality.”
But this is heresy from the point of view of what has been the reigning economic orthodoxy since the 1970s. Its adherents argue that the extra spending and borrowing has boosted the money supply, causing the rise in inflation.
There are two problems with this analysis. The first is that its exponents have been crying wolf for over a decade.
The policies they denounce began in a more moderate form in 2007-8, when central banks responded to the global financial crisis by creating money and pumping it into the financial system. Free marketeers denounced this as an abomination that would lead to hyper-inflation. In fact inflation stayed very low or was even negative until very recently.
Secondly, there is a better explanation for the inflationary surge, which focuses on supply rather than demand.
The economic shutdown provoked by the pandemic disrupted the transnational supply chains that radiate from Asian factories to Europe and North America. According to the Financial Times (FT), manufacturing delivery times have lengthened in recent months at the fastest rate since records began in 1998.
“It is advanced economies that wait for parts and goods largely produced by China and other Asian countries that are most affected. Call it the bullwhip effect—where changes in demand have a bigger impact the further along the supply chain you go—in action,” said the FT.
“Delivery times have worsened the most in the tech and auto sectors, where they are short of microchips, but manufacturers of food and beverages and personal items are experiencing near-record disruptions.” However caused, inflation is cutting into living standards. The bosses and their economists are most afraid of a “wage‑price spiral”—in other words, workers reacting by demanding higher wages and capitalists defending their profits by raising prices further.
This isn’t happening yet. According to a survey by XpertHR, over four fifths of British private employers plan to raise wages, taking the median pay award to 2.5 percent, well below inflation. But the labour shortages that are another effect of the pandemic may give many groups of workers the power to defend their real wages.
The free market right is preparing to strike back. Pill is a protege of Otmar Issing, the first chief economist of the European Central Bank and a disciple of the other neoliberal godfather, Friedrich von Hayek. Ignoring how central banks have been actively intervening to maintain demand, Pill told the FT the Bank of England is “an institution that’s in the price stability business”.
Meanwhile, chancellor Rishi Sunak, when asked by a journalist to choose between Keynes and Friedman, opted for Friedman. We’ve been warned. Winter—higher interest rates and Thatcherite austerity—is coming.