In the world of monetary policy, from the 1960s onwards, inflation was “always and everywhere a monetary phenomenon,” as Milton Friedman, who later won the Nobel Prize for Economics, put it in a lecture in India in 1963.
He believed he had found out that increases in price levels ultimately had nothing to do with aggressive unions, profit-maximizing entrepreneurs or oil cartels.
“If you control the growth of money, you control inflation,” as Friedman put it. Ultimately, inflation is always the result of a poor, i.e. too lax, monetary policy – which many Germans in particular would spontaneously subscribe to today, given the sharp rise in consumer prices and negative savings rates.
As a foundation for his mantra quoted at the beginning, Friedman tried the quantity equation, according to which the amount of money multiplied by the velocity of money always corresponds to the price level multiplied by the average number of transactions taking place in a period.
If one assumes that the trading volume and the speed of circulation are constant, then the price level is influenced solely by the money supply and thus by the central bank. So stable prices only require control of money supply growth, Friedman preached.
Now this simple connection may have had a certain relevance in the mostly still strongly domestically oriented economies of the late 1960s and early 1970s. But today a big question mark has to be raised behind the thesis that the big central banks can control inflation even halfway precisely through a policy based on the money supply.
And although a number of economics professors and journalists still attach great importance to the development of the money supply, there has not been a central bank for some time that has followed this concept. Rather, the declared goal today is to control inflation expectations – and thus be able to keep actual inflation in check.
Sure, at first glance the big central banks have succeeded in sustaining the high inflation rates of the 1970s with aggressive interest rate hikes and kept inflation rates quite low in the industrialized countries for four decades.
However, it is not so clear what part the central banks actually had in this world of stable prices despite strong economic growth – and what part completely different factors.
Because in the past few decades, many consumer goods have become cheaper and cheaper as a result of the integration of the former Eastern Bloc as well as China and other emerging countries into world trade.
At the same time, wages rose moderately in most industrialized countries, as employers could plausibly threaten to relocate production to low-wage countries. In addition, many formerly analog products have been replaced by cheaper digital products.
But this era of low price increases and flat wage developments could now be drawing to a close. On the one hand, wages in China and other Asian countries with strong exports have risen noticeably. Further price reductions via imports are therefore not to be expected.
In addition, as the industry is now painfully experiencing, Europe is dependent on deliveries from the Far East for semiconductors. Such dependencies create scope for permanent price increases on the part of suppliers.
In addition, the economic superpowers on both sides of the Pacific are increasingly questioning the advantages of the global economic division of labor and free world trade and are resorting to protectionist measures.
China seems to continue to seal itself off from abroad under the guise of fighting corona, while the US apparently wants to stick to the punitive tariffs imposed on Beijing. Even US President Joe Biden is by no means a great advocate of free trade.
And so the incumbent US government should, if necessary, use the full range of instruments to enforce the interests of the USA, the economy of the country and those who work there. In plain language: New punitive tariffs are a conceivable option in Washington. However, further trade barriers would not only dampen economic growth, but also lead to higher prices.
In addition, the world’s population is aging. In 1990 the global median age was 24 years, today it is 31 years and could be 42 years in 2100 (according to the UN forecast for average fertility).
The irreversible massive aging of the population in Germany and other European countries will intensify the shortage of skilled workers and thus certainly lead to rising wages and rising prices.
Prof. Bert Rürup is President of the Handelsblatt Research Institute (HRI) and Chief Economist of the Handelsblatt. For many years he was a member and chairman of the Advisory Council as well as an advisor to several federal and foreign governments. You can find out more about the work of Professor Rürup and his team at research.handelsblatt.com.
There is therefore much to suggest that the era of very low price increases is coming to an end, regardless of whether the major central banks continue their ultra-light monetary policy, which they have embarked on for some time, or whether they gradually exit this policy.
Whether the key interest rate in Europe is zero or three percent will therefore have no relevant influence on how prices for consumer electronics made in the Far East, for example, or for raw materials on world markets develop in this country. The central banks are powerless against such price fluctuations.
But monetary policy is not only powerless against demographically induced or imported inflation; A restrictive monetary policy that is strictly oriented towards monetary stability can cause major ecological damage even with a view to climate change.
Because the declared and correct goal of most industrialized countries is to counter climate change through significantly lower emissions of the greenhouse gas CO2. This is to be done through higher prices for fossil fuels.
A rise in energy prices is desirable
Market-based incentives to save energy and switch to renewable energies are to be set through price increases. The associated noticeable rise in prices is expressly desired. If the calculation of a policy based on climate protection through CO2 taxes or emissions trading is to work out, there must be noticeable price increases for a large number of products, not least due to rising manufacturing and transport costs.
This would be a politically desirable increase in the interests of changing consumer behavior. It is obvious that monetary policy should not respond to this by raising key interest rates.
But what if the rising energy costs resulted in the unions pushing through massive wage increases to compensate for inflation? Actually, the beginning of such a wage-price spiral would be a clear signal for monetary policy countermeasures.
Against this background, the question arises whether the mandate of the central banks is really still in keeping with the times. How should a central bank pursue a fixed inflation target when politicians themselves deliberately want to continuously increase the price of a large number of goods?
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