Inflation Blues

by Pavlos Roufos

2022 saw the spectre of inflation rear its head. Many left-leaning commentators, used to dismissing inflation concerns as right-wing fear-mongering, appeared to be caught off-guard. Some spoke of a return to the 1970s, and we saw an uptick in struggles over pay rises and utility bills. Building on an interview with Tous Dehors, we asked Pavlos Roufos how should we understand inflation today.

Endnotes: What is inflation, exactly?

Pavlos Roufos: In everyday language, inflation is simply a sustained increase in prices. There is, however, nothing simple about this. Which prices exactly are rising? Official measurements of inflation (used by central banks, the state and other financial authorities) look at the Consumer Price Index - CPI, i.e., a basket of specific commodities regularly consumed by households. This immediately means that other prices are excluded: most notably, for example, while rent costs (shelter) are included in the CPI, increases in real estate prices (considered an ‘investment asset’) are not.1 In the world we live in, overall rising prices in the housing market are seen as “economic growth” (as something positive), whereas higher wages as something threatening that has to be crushed.

Another way of describing inflation is summed up in the economists’ phrase: “too much money chasing too few goods”. That seems more specific than the previous definition but after scratching the surface a whole range of problems reveal themselves: “too much money” in relation to what? Is there a fixed, objective amount of money that designates a limit? How is that calculated? The second part of the sentence also has issues: “too few goods” in relation to what? Usually, of course, the phrase is interpreted as describing a relation between the two: there is more money available than existing goods/services. But this does not help much either. Not only does this imply the existence of a supposedly optimal relation between “money” and goods/services while ignoring other determinants (financialization would be an obvious one), but it also has nothing to say about the causes of inflation: how do we arrive at such a disequilibrium between “too much money” and “too few goods”? Was there a surge in demand for more goods or was there a drop in supply?

Trying to understand how inflation plays out in the real economy, further complications arise. As the Bank of International Settlements pointed out in a recent paper, there is a crucial difference between relative price changes in specific commodities and underlying inflation, a situation where there is a broader-based and synchronous increase in prices that erodes the value of money - meaning that what one’s money could buy today is not the case for tomorrow. In the beginning of 2021, many argued that inflaion was a transitory phenomenon driven by temporary supply/energy shortages or blockages that could be resolved, i.e., that only relative price changes were taking place. Soon after, however, the fear was that this had developed into underlying inflation, affecting all prices and showing signs of becoming structurally embedded, i.e., far from transitory. Now that inflation seems to have slowed down, talk of transitory inflation is back on the agenda.

If one thing is clear it is that inflation cannot be understood on its own. It expresses a set of relations and interactions between money, production, distribution, supply and demand, etc., categories which are far from straightforward in themselves, let alone in relation to each other. One’s perspective of these relations can hardly be neutral, for they necessarily touch upon deeply political questions. Disagreements about inflation (whether we are talking about its causes or measures to fight it) reflect underlying political disagreements. Inflation talk can thus shed light onto what people more generally think about the economy, the state, money and labour.

For example, it has become a dominant idea in certain policy circles that inflation rates above 2 per cent are a source of instability. This idea is actually quite recent: up until the 1980s much higher rates of inflation were normalised and tolerated (even supported in some cases). It's nonetheless true that inflation has consistently been seen as a destructive phenomenon from a certain liberal or neoliberal perspective. The reason: inflation erodes the value of money and, therefore, wealth. Hence the persistent obsession with “sound money”, a policy objective of keeping inflation at extremely low (even zero) rates. It is only in this context that one can understand why the ECB’s recent projection of 4.2 inflation for next year is seen as alarming enough to support further monetary tightening.

E: OK, but what do you see as causing the recent bout of inflation?

P: It appears to have been driven by three factors. First, supply chain blockages, a residue of Covid restrictions and shutdowns, directly affected the global supply of goods. These restrictions tended to be felt most acutely in specific commodities, whose role is rather central across different spheres of production.2 Many, for instance, have pointed at the shortage of semiconductors that caused a series of constraints on manufacturing.3 Second, the energy crisis: energy prices were already heating up in 2021, but this was radically accelerated by Russia’s invasion of Ukraine, the sanctions that followed and the decision to disentangle (mainly but not only European) economies from Russian energy sources. Among other things, this brought a sudden entrance of big players (such as the EU or China) into the market for energy alternatives, pushing prices sky high. Third, and as a consequence of the previous two, a changed dynamic of capitalist competition, namely the ability of specific large companies to take advantage of the supply blockages to push prices up in the knowledge that their competitors were as restrained as they were and could not, therefore, gain market share by keeping prices low, as Isabella Weber argued recently.

In relation to the third reason, a further qualification is perhaps necessary. Many people, and that is visible on the left too, have interpreted current inflation as the result of profiteering. The problem with this concept is that it implies a level of normal profit making that is acceptable and causes no issues, but then corporations take advantage of specific conditions in order to reap excess profits. This obscures the fact that so-called normal profit making, as the cornerstone of the capitalist economy, is in itself a fully destructive process (with the climate catastrophe being the most obvious example). The concept of profiteering suggests a kind of corruption, a distortion of normal profit making, a form of unacceptable excess against a naturalised capitalist normality.

Furthermore, some have linked the capacity of corporations to take advantage of historical situations to increase their profits to the concept of monopolisation. Coming from the neoliberal side, which has a long history of anti-monopoly/anti-cartel opposition, this makes sense: monopolies distort the market and the price mechanism and are, as such, detrimental to the functioning of the market economy. The left’s adoption of the anti-monopoly perspective remains a puzzle however. Leaving aside the persistent tendency of stalinists to describe capitalist social relations through this pseudonym (i.e. “monopoly capitalism”), opposing monopolies makes sense only from the perspective of a more effective competition process (which is, of course, why neoliberals are so concerned with monopolies). A critique of the capitalist order, however, is not strengthened by promoting a more truly competitive order.

In any case, we do not live in a world of monopolies or cartels. While specific corporations have larger market shares and capital concentration is a structural phenomenon of the capitalist economy, competition remains the central way through which nodes of capital relate to each other - and today’s inflationary pressures have more to do with changing dynamics of competition, rather than its absence. Lamenting the absence of real competition between capitalist enterprises is not, nor has it ever been, the task of those critical of the capitalist economy.

E: Another theory that one often hears is that of a “wage/price” spiral. Have rising wages contributed to inflation?

P: There might be some merit to the wage/price spiral theory if there were, in fact, rising wages. The problem is that there has been no such thing. In fact wages in most developed countries have tended to be stagnant, if not falling, in recent years. Even in sectors where labour has greater leverage (for example, organised metal workers in Germany), union negotiations in the last year only achieved a wage increase that fell below the inflation rate. Over the longer term wage growth in the economy as a whole has tended to lag behind productivty growth, such that the wage share has fallen dramatically decreased since the 1970.

Now it is true that in some sectors and in specific countries we have seen wage increases that exceed productivity increases, such as in the service sector in the US. But two things are crucial to keep in mind here: first, service sector productivity always tends to be low, so there is nothing suprising about this. Secondly, even if specific US services saw such increases, this is far from an overall phenomenon – either within the service sector as a whole or in other economies outside the US, like European ones. Explaining a policy shift towards higher interest rates (which means recession) at a global level by pointing at a specific sector in the US is simply nonsense.

There are various historical reasons for this tendency towards wage stagnation. At a social level, one can point to the decline of the labour movement since the 1970s. At a political level, one can point to the transformation of social democracy and reformism into political vehicles of neoliberalisation. Both can further explain why economic policies have remained locked in a specific neoliberal paradigm: the lack of effective social antagonism and the disappearance of even reformist alternatives. But a wider framework is perhaps also necessary. At this point, for me, Brenner’s work offers a convincing approach. He points at crucial determinants such as over-capacity, de-industrialisation, liberalised capital flows and a consequent fall of productivity, as short-term profitability overtook a more long-term approach that could combine capital and labour in ways that enhance productivity. Finally, and crucially, we can point to the proliferation of household debt (and the changing dynamics that credit and debt acquired through global markets) as a way of ‘papering over’ stagnant or lower wages by offering a fictitious increase in purchasing power.

Going back to the question of the wage/price spiral. Contrary to the ‘sound money’ left that also sees inflation per se as a threat because it takes it as a given that workers will not be able to fight it, mainstream economists and central banks do in fact fear that rising inflation will force workers to demand higher wages to offset the decrease of their purchasing power. When that happens however, they claim, higher labour costs ‘force‘ capital to further increase prices in order to compensate for the rising wages. This is their view of the wage/price spiral, where each side pushes the other further and, in the end, ‘everyone loses‘, as the official narrative goes. The fact that the only ‘realistic’ solution against this is lowering wages is indicative of how profoundly political and ideological the perspective is.

In any case, however, the reality is that authorities like central banks look at wage moderation (i.e. wage decline) as a suitable way for offsetting inflation regardless of its causes. Whether current inflation is demand-driven or supply-driven, central banks respond in the same way: bring down wages. They are basically saying to people: “to return to monetary stability you need to earn less”.

E: What about quantitatve easing (QE)? Couldn't the fact that central banks were creating so much money have contributed to inflation?

P: If one defines inflation as “too much money chasing too few goods” it’s easy to look only at the first clause and focus narrowly on changes in the money supply. Thus many have tried to argue that the current inflation is the belated consequence of massive infusion of money into the economy by central banks through quantitative easing (bond purchasing) programs, put in place after 2008 (for the Fed) and 2014 (for the ECB).

The main problem with this narrative is that it fails to explain the time lag: since QE started 15 years ago, why did it only bring inflationary pressures now? Why not before? The unprecedented increase in the money supply (we are speaking of trillions of dollars by the Fed alone) should have already expressed itself in inflation long ago. This did not take place however. We have had years of money supply increase without any sign of inflation - in fact, if one followed discussions of central banks until last year, the actual threat was the opposite: deflation.

To understand this we need to see that an increase in the money supply per se does not tell us much. Not only is the specific monetary aggregate used to measure the “money supply” a contested issue, but the real question is: “if central banks printed so much money, where did that money go?” Was it handed over to consumers, to boost demand? Did it go towards public spending, welfare increases, pension raises? Was it directed towards productive investments, infrastructural repairs, research? In short: did QE increase overall spending and revert decades of monetarism into a renewed fiscal dominance? There is zero evidence for that. But we know that QE was used to fund corporate buy-backs, that it inflated stock market and housing bubbles, but we have seen no sustained increase in public spending or wages.

To undertand this I also think a wider framework is necessary, and I find Daniela Gabor’s work indispensable: rather than pointing towards a return to state-led “fiscal dominance”, Gabor shows that QE should be understood as a support mechanism for the contemporary macro-financial regime, where money markets, securities, derivatives and other high risk instruments increasingly rely on safe collateral. For Gabor QE represents the transformation of the government bond market into a “collateral factory” for money markets, rather than a printing-machine that brings money into household or state budgets. Linking this insight to the afore-mentioned problem of decreased productivity (and, thereby, lower returns for capital investment), a different picture emerges where QE can be seen as necessary for the stability of the macro-financial regime without being able to generate growth or return to state-led fiscal dominance.

From this perspective it is clear why if there was any “inflation” caused by QE in the last decades, it was asset inflation. What is peculiar in some recent discussions about inflation on the left is that this fact (the creation of asset inflation and bubbles) is seen as a good enough reason to condone the end of QE and the raising of interest rates, suggesting that a return to ‘sound money’ will be beneficial to workers who see their wages eroded by inflation. But while it would be absurd to argue that there is some automatic relation between inflation and workers’ struggles, it is even more absurd to see a policy-induced recession, resulting in a sharp contraction of workers’ purchasing power and rising unemployment, as a preferable solution.

E: Why, then, are central banks responding to the threat of inflation by rolling back QE and raising interest rates?

P: After the collapse of the gold standard, central banks acquired a new role. Instead of focusing on the stability of currency exchange rates in relation to existing gold reserves, they were now focused on controlling the domestic price level via the money supply. Armed with a series of monetarist models (such as Friedman’s proposal to sustain a 5 per cent yearly money supply increase or the claim that 2 per cent inflation is optimal), they embarked on interest rate manipulation to preserve what they defined as price stability.

This was an era of growing central bank independence, but there was, however, nothing depoliticized about these choices. A monetarist perspective on issues like inflation or price stability has consistently meant that central bank actions have responded to the threat of inflation by lowering the wage share. This is not simply an ideological bias: it is structurally determined by the instruments that central banks have at their disposal: higher interest rates reduce the wage share while increasing the wealth of creditors and savers.

This is what we see today. Even if central bankers agree that current inflation trends are the consequence of energy costs and supply chain disruptions, it is clear that increasing interest rates does not (and cannot) address such issues. There is no interest rate that can unblock supply chains or reduce energy costs. What raising interests does address is the demand side of the relation by making borrowing more expensive, reducing investment and job creation, causing a recession and higher unemployment. Under these circumstances, and central bankers have been remarkably frank about this, workers lose their ability to negotiate higher wages and suffer a decrease of their purchasing power, lowering demand.

We thus have the peculiar (if you think about it) argument that the answer to lower purchasing power (which is a consequence of inflation and also a reason why inflation is bad for all) is to … decrease workers’ purchasing power even more. The idea is that diminishing demand will eventually bring down prices, which basically means that making people poorer is their preferred way to bring about price stability. Unless we understand central banks as having a class perspective, their actions stop making sense. The choice to address a supply problem by crushing the demand side is as political as you can get.

The underlying logic is obvious: even if the capacity of the working class to organise collectively and effectively has been radically diminished in the last 30 years or more, fears that the working class might increase its ability to negotiate better conditions become more threatening in a wider context of stagnant or declining productivity. In such an environment, even a moderate increase in the wage share is seen as detrimental for capitalist interests, leading state and capital – once again – to prefer the risk of a recession to any potential strengthening of working-class power.4

E: At the moment (March 2023), inflation rates in the US and Europe have been falling for several months. Could we be witnessing the so-called “soft landing” promised by some central bankers?

P: It is crucial to note that if inflation is actually going down, it is not the result of central banks tightening. As I already mentioned, there is no interest rate that can solve higher energy costs or supply chain shortages. If those issues have been eased, it is not the result of higher interest rates (the increase of which has been historically modest, if we compare to the Volcker shock for example). But even more importantly, central bankers themselves admit that the effects of monetary tightening on general prices cannot happen so quickly. According to research done by the Fed itself, the peak effect of rate hikes on prices comes after a minimum of two years – with significant effects translating into real activity in the 4th year. As Josh Mason has noted, this means that central banks are now “setting policy for the year 2024 or 2025”. On top of that, even though inflation trends seem to be slowing down, both the Fed and the ECB seem prone to continue listening to their hawkish advisors and to retain tightening.

This means that while inflationary pressures might have already receded by that time, the recession is nonetheless coming, and it is purely policy driven. As the IMF chief recently admitted, recession is in fact coming for – at least – a third of the world in 2023. If one considers central banks to be objective institutions led by scientific and depoliticized models in pursuit of the noble cause of price stability for all, this would appear to be an entirely irrational choice. But if we understand central banks as instruments of class power, none of this is in the slightest surprising. If the long-term trend is indeed one of declining productivity and profitability, with companies engaged in cut-throat competition to increase market share in a diminishing market environment, while at the same time there a potential for working class empowerment appears, causing a recession is a very specific and political way of intervening in that conflict.