Middle East

Balanced response to inflation

Due to the resumption of the global economy after the blockade of COVID-19, some supply shortages were expected, but they were more prevalent than expected and proved to be non-temporary. In a market economy that is at least partially dominated by the laws of supply and demand, shortages are expected to be reflected in prices. And when individual price increases are grouped together, we call it inflation. This is currently at a level not seen for many years.

Nonetheless, my biggest concern is that the central bank overreacts, raising interest rates too much and hindering the initial recovery. As always, in this scenario, the people at the bottom of the income scale will suffer the most.

In the latest data, some points stand out. First, inflation is volatile. Last month, the media took full advantage of the US annual inflation rate of 7%, but did not realize that December’s inflation rate was more than half that of October. With no evidence of inflation-indexed bonds, market expectations are reflected in the difference in returns between price-linked and non-inflation-indexed bonds and are adequately restrained.

Energy prices are one of the main causes of rising inflation, rising at a seasonally adjusted annual rate of 30% in 2021. There is a reason why these prices are excluded from core inflation. As the world moves away from fossil fuels, investment in fossil fuels can decline faster than the increase in alternative supplies, as climate change needs to be mitigated, which can incur migration costs. But what we are seeing today is the naked exercise of market power by oil producers. Knowing that their days are being counted, oil companies are reaping any profit they can still make.

Soaring gasoline prices can be a big political issue, as all commuters are constantly facing gasoline prices. But after gasoline prices return to the more familiar pre-COVID levels, there is no doubt that they will not fuel the rest of inflationary momentum. Again, sophisticated market observers are already aware of this.

Another big issue is used car prices. This highlighted a technical issue regarding how to build the consumer price index. Higher prices mean that sellers are better than buyers. However, the US Consumer Price Index (unlike other countries) only captures the buyer side. This provides another reason for inflation expectations to be relatively stable. People know that rising used car prices are a short-term anomaly that reflects a shortage of semiconductors that are currently limiting the supply of new cars. We know how to make cars and chips today as we did two years ago, so there’s good reason to believe that these prices will fall and cause measured deflation.

Moreover, given that most of today’s inflation is due to global issues such as tip shortages and oil cartel behavior, it is an exaggeration to blame inflation for excessive US financial support. Acting on its own may have a limited impact on global prices.

Yes, the United States has slightly higher inflation than Europe. But it also enjoys stronger growth. US policy has prevented a significant increase in poverty that would otherwise have occurred. Recognizing that the cost of being too small can be enormous, US policymakers have done the right thing. In addition, some of the rise in wages and prices reflects a healthy balance between supply and demand. Higher prices indicate shortages and are supposed to redirect resources to “solve” the shortages. They do not represent a change in the overall capacity of the economy.

The pandemic revealed a lack of financial resilience. The “just-in-time” inventory system works well as long as there are no system problems. But it’s easy to see that even a small mess can have big consequences, such as when A is needed to generate B and B is needed to generate C.

Similarly, the market economy tends not to adapt very well to major changes such as near-complete shutdowns and subsequent restarts. And that difficult transition took place after decades of short-term workers, especially those at the bottom of the wage table. It’s no wonder the United States is experiencing “mass layoffs.” Workers are quitting their jobs in search of better opportunities. If the resulting decline in labor supply leads to higher wages, it will begin to correct for decades of weak and nonexistent real (inflation-adjusted) wage growth.

In contrast, rushing to curb demand each time wages begin to rise is a surefire way to ensure that workers’ wages fall over time. As the Federal Reserve is currently considering a new policy stance, wages and prices are becoming less nominally rigid, requiring higher optimal inflation during periods of rapid structural change. It is worth noting that it is often (that is, what rises rarely falls)). We are at that time, and don’t panic if inflation exceeds the central bank’s 2% target, a rate that is not economically justified.

An honest explanation of current inflation requires a large disclaimer. We have never experienced this before, so we cannot be sure how things will evolve. There is no doubt that the workers at the bottom get angry, but they don’t know what to do with the great resignation. Many bystander workers can be forced back to work when cash is out of stock. But if they are dissatisfied, it can show up in productivity figures.

That’s all we know. A full-scale rise in interest rates is a worse cure than illness. Supply-side problems should not be attacked by reducing demand and increasing unemployment. If taken enough, it may weaken inflation, but it will also ruin people’s lives.

Instead, what is needed is targeted structural and financial policies aimed at eliminating supply bottlenecks and helping people confront today’s reality. For example, food stamps for the poor should be indexed by food prices, and energy (fuel) subsidies should be subsidized by energy prices. Beyond that, temporary “inflation-adjusted” tax cuts for low- and middle-income households will help them through the post-pandemic transition. It can be funded by taxing the monopoly rent of oil, technology, pharmaceuticals, and other giants killed from the crisis.

As the world moves away from fossil fuels, some migration costs are expected, but what we are seeing today is the bare exercise of market power. Knowing that their days are being counted, oil companies are reaping any profit they can still make.


Joseph E. Stiglitz

The Nobel laureate in economics is a university professor at Columbia University and a member of the Independent Committee for International Corporate Tax Reform.


Times Kuwait Limited
© Copyright Project syndicate


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