I know, I know. It is supposed to be about too much money chasing too few goods – but, more fundamentally, what is it about?
I ask this question partly because there is now so much disagreement about this, even among economists. But partly also because I remember Michael Rowbotham, in his influential 1998 book The Grip of Death – the book that raised the curtain on the set of beliefs we now know as MMT or modern monetary theory – had an answer. He said:
“Inflation is not caused by too much money; it is caused by too much debt-money… The whole principle of changing from a debt-based to a credit-based economy is that money needs to be created, both to provide a stable money stock and to allow repayment of excessive debts… As long as it is created free of debt, distributed in the right way, and with parallel supporting measures, such money can be created in complete safety. It will not cause inflation and will simply support the functioning of the economy. The debt-free money distributed as a basic income would not cause spiraling inflation, runaway inflation, soaring inflation, hyper or mega inflation, or supa-dupa-cosmic inflation with flashing lights and sirens. It will not cause inflation because, in a modern economy, inflation is not caused by too much money …”
More fundamentally said Rowbotham, inflation is caused by human greed…
I can see what he meant. But I have a feeling that it is even more fundamental than that: inflation is caused by inequality. The more unequal the people using a currency are, the more prone to inflation it will be.
Take our current situation. Prices are rising primarily because food and fossil fuels are both scarce – mainly because of the Russian invasion of Ukraine.
They are rising faster because our economies are now so interconnected, and because the fine mesh of local business has been trashed and ignored by successive governments.
But where does too much money come in? I mean, if oil and gas prices carry on rising as fast as they are doing, then – in theory at least – that should have the same effect as raising interest rates.
By taking money out of the economy, shouldn’t it lower prices?
And if all things were equal, that is what it would do – but they are not. In fact, so much of our economy in the UK now panders to the ultra-rich that it has worn grooves where the money flows towards them. It gathers around them like great fatbergs and the inflation gathers there too. Then, hey presto! It spreads around.
In that respect, I think those economists around Liz Truss may be right not to emphasise the conventional treatment for inflation – rising interest rates – because that may not be effective.
Of course, giving out tax cuts won’t help very much either (quite the reverse!).
Raising interest rates will simply undermine house price inflation – which we badly need to do – but that won’t help reduce the cost of food and fuel.
So what can we do? First, levelling up or down has never been more urgent.
We also need to tackle the shortage of gas by replacing the 44 per cent of UK electricity that is currently provided by gas – and with offshore wind now down to 37p per kWh (a third of the cost of power from the Hinkley Point white elephant), we have maybe some chance of doing that.
Unlike homes, the demand is not endless for fuel here. You can’t build your way out of house price inflation, because far eastern investors will simply swoop in and buy them up. You can provide enough energy.
Thirdly, we need a larger proportion of our money to be created free of debt, for the reasons that Mike Rowbotham set out. Otherwise all but three per cent of our money supply has to be paid back to someone – plus a bit. It has inflation already baked into it.
Finally, we need to remake the economy – so that it isn’t any more dominated in any sector by a handful of megacorps.
I have become convinced that the anti-trust blogger Matt Stoller is right to blame the failure of American regulators to prevent oligopolies building up for inflation.
Maybe it is just as Michael Rowbotham said – at root, inflation is a symptom of the greed of a society.
Stephen Gwynne says
There is a difference between demand pull inflation, cost push inflation and base effect inflation.
much of UK inflation is demand pull resulting from high international gas prices which constitutes much of our base load electricity.
This base load cannot be substituted with intermittent curtailed renewable energy without sophisticated storage capacity or else a transnational grid that reduces the need for curtailment.
The only current substitute is nuclear or interconnectors with the latter unreliable due to energy constraints on the continent.
Building out more renewables increases demand pull inflation due to hydrocarbon entanglement.
Inflationary tax reductions within this international context offsets deflationary reductions in discretionary income in order to reduce the likelihood of economic contraction so the net effect is zero.
The rest of UK inflation is cost push as a result of an overheated labour market with more job vacancies than the number of unemployed. The market puts an upward pressure on wages which is passed on to consumers as a service cost.
BoE interest rate rises specifically seeks to reduce discretionary income through increased housing costs to contract the economy, leading to job losses and cooling down the labour market.
If demand pull or cost push inflation develops as a trend, then the market will begin to build in expectations that inflation will persist and cost in inflation. This is known as base effect inflation which is why it is perceived as important for the BoE to be active rather than passive.
Since current inflation can be adequately explained in orthodox ways, then the MMT explanation doesn’t carry much weight unless it can be explained how debt driven monetary policy affects demand pull or cost push dynamics.