Handelsblatt International correspondent Torsten Riecke analyzes interesting data and trends from all over the world in his weekly column. You can reach him at [email protected]
(Photo: Klawe Rzeczy)
The Society for the German Language will announce the word of the year this Friday. One of the favorites is likely to be “inflation”, which our neighbors in Austria have already opted for.
No word was on everyone’s lips in 2022 as much as that which economists define somewhat technocratically as the rate of price increases. And no other word has been so much debated as inflation, its causes and consequences.
Time has now decided the dispute over whether inflation is a temporary or permanent problem – also because price expectations and prices remain high the longer the specter of inflation is painted on the wall. Much more interesting, however, is the question of whether it is of inflation is a monetary or a fiscal phenomenon.
Many economists thought the matter had actually been decided since 1963. At that time, Milton Friedman, winner of the Nobel Prize in Economics and father of the monetarists, famously said: “Inflation is always and everywhere a monetary phenomenon.” Monetary and fiscal politicians then derived the following division of labor from this: central bankers ensure monetary stability and governments ensure economic growth and employment.
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The global stagflation – hardly any growth at the same time as rising prices – has now confused everything. US President Joe Biden first fueled inflation with his multi-trillion dollar stimulus plan and then tried to get inflation under control again with his “Inflation Reduction Act”.
Monetary and fiscal policy should move in lockstep
In Great Britain, the announcement by short-term Prime Minister Liz Truss that she would finance growth on credit was enough to ring all the alarm bells at the monetary watchdogs of the Bank of England.
Many economists have therefore learned from these fiscal escapades that monetary and fiscal policy should always move in lockstep. Or, to put it in the words of French Finance Minister Bruno Le Maire: “The tightening policies of central banks are ineffective if public finances continue to grow.”
The American economist Thomas Sargent, also a winner of the Nobel Prize in Economics and a fan of rational expectations, goes one step further. “Persistently high inflation is always and everywhere a fiscal phenomenon in which the central bank is an accomplice in monetary policy,” Sargent contradicted the old master Friedman back in 2013.
His colleague John Cochran from the conservative think tank Hoover Institution derives a “Fiscal Theory of the Price Level” from this and warns: You get more inflation if the citizens no longer believe that the state can repay its debts.
>> Read here: What top economist Olivier Blanchard thinks about the further development of inflation
His argument is simple. If the state runs out of money and can no longer sell new promissory notes to investors, the central bank starts the money press and inflation rises. Critics of the loose monetary policy see exactly this vicious circle at work in the massive bond purchases by the central banks (quantitative easing) after the pandemic.
At first glance, Sargent and his followers not only turn Friedman’s monetarism upside down with their fiscal inflation theory, they also leave Neo-Keynesians perplexed: after all, their economic policy orthodoxy states that fiscal policy should act like an airbag when the central bank is in a fight steps on the brakes against inflation and raises interest rates. A government austerity program in the middle of a recession, on the other hand, only makes things worse for most people.
Theory and reality are far apart
In addition, a fiscal policy explanation of inflation is empirically on shaky ground. After the financial crisis of 2008, the national debts of many countries also rose enormously, but there was no sign of an inflationary surge. On the contrary: A long era followed with inflation rates close to zero, to which central bankers reacted with those unconventional bond purchases that are now allegedly partly responsible for inflation.
>> Read here: Inflation may even be overestimated from a long-term perspective – one comment
So if “inflation” really does become Friday’s word of the year, let’s remember that over the past year many have been ranting about something that even Nobel laureates in economics cannot adequately explain. The only consolation is Kurt Tucholsky’s bon mot, one of the greatest artists in the German language: “National economy is when people wonder why they don’t have any money. (…) Where the money comes from is unknown. It is either there or not there – mostly not there.”
More: ECB chief economist signals further rise in interest rates in the fight against inflation