It's Necessary to Discuss Inflation - the Indicators of Danger are Still Present

Economic policymakers worldwide must not overlook the significance of Stephen D King's recent book, which is incredibly relevant and should be considered a must-read.

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Nowadays, it's not common to see universities teaching economic history. Unfortunately, this is a shame because it offers more practical guidance for policymaking than the theories that win Nobel Prizes in economic theory. Consequently, we repeat costly policy errors every couple of generations. The Truss government in Britain is an example of this, as they neglected to analyze the Barber Boom that took place in 1972-73. Similarly, the central banks worldwide have also failed to learn from the shocks in oil prices that occurred in 1973 and 1980.

Stephen D King's book is a great read and it's very informative. Its title is perfect. It's important to discuss inflation because it's random and unfair. People who save money are punished while those who are wasteful are rewarded. It also makes planning difficult and allows the government to tax people secretly by freezing tax thresholds and reducing real wages for their workers.

In this blog, the author discusses the impact of inflation over the course of history, spanning 2,000 years. They highlight noteworthy events, such as Emperor Diocletian's monetary debasement and the Federal Reserve's recent decision to permit inflation to surpass the 2% mark. The main message conveyed is that the amount of money in circulation has a direct effect on the rate of inflation. However, managing monetary supply is not a foolproof solution to combat inflation. Despite the popular monetarism approach, there are still limitations in controlling inflation through this method.

Having faith in a currency is important because if it's lost, people start to lose trust in the organizations that support it. Two examples of this are the experiences of Argentina and Brazil. However, there are lessons to be learned from the histories of developed economies too. In the 19th century, when the gold standard was at its peak, the worth of sterling rose by 48%. On the other hand, in the 20th century, when both the gold standard and the post-1945 Bretton Woods system, which set fixed exchange rates, collapsed, the purchasing power of sterling dropped by a whopping 98%.

Inflation is often the target of blame by governments when it starts to increase. It's clear that recent supply chain issues due to the pandemic and the rise in energy prices caused by the conflict in Ukraine have contributed significantly to this increase. However, it's essential to note that the rampant inflation is also a result of the excessively relaxed approach to monetary policy in recent times.

The blog post "We Need to Discuss Inflation" by King acknowledges the significant issue of identifying whether instances of inflation are only temporary, such as during the Korean War, or if they will be ongoing. King outlines four tests that can be carried out to determine the answer.

To start off, let's discuss whether there have been any changes within institutions that suggest a preference towards inflation. According to King, it's possible that central banks' aversion to deflation over the past ten years has caused them to lean more towards inflation. He also notes that quantitative easing has affected the bond market, removing an important indicator that central banks used to assess the risks of inflation: the movement of prices in government paper. Additionally, quantitative easing has blurred the lines between finance ministries and central banks, drawing the latter into the negative influence of fiscal decision making.

Next, is there any evidence of excessive money supply that could lead to higher inflation? In this regard, King highlights the escalated level of monetary growth in the United States amid the pandemic.

Next, is inflationary danger being downplayed or disregarded? Over a span of 2.5 years, the United Kingdom's annual rate of inflation escalated from 0.3 per cent up to 10 per cent. However, during that timeframe, the Bank of England kept predicting that the inflation rate would promptly decrease and stabilize at the 2 per cent mark within two years.

Are the supply conditions worse now? Even though the pandemic's supply chain issues may be improving, trade obstacles, which are usually wrongly portrayed as improved national resilience, are increasing. Furthermore, despite the advantages of Brexit in terms of "taking back control," it seems that it has harmed the British economy's ability to expand.

Some people may say that King's tests were specifically designed to reach the conclusion that inflation would go up and stay up, but that doesn't necessarily mean he's mistaken. While inflation may start to decrease over the course of this year, it might be tempting to assume that it will automatically go back to the desired level. This seems to be the perspective of both the central banks and the financial markets.

However, the indicators of a potential problem are still present. The job markets continue to have little room for improvement, and there are still a high number of job openings available.

Although real interest rates are still in the negative zone, there might be an introduction of quantitative tightening. Nevertheless, central banks still possess incredibly large amounts of government bonds, which implies that monetary conditions are still relaxed.

The King is worried that central banks have been given too many goals to achieve. He thinks that it may be hard to achieve all the objectives they have been given at the same time, like making sure the money system is safe, everyone has a job, finance is green, and making sure the Euro stays strong. This means that central banks have had to make tough decisions that they may not have wanted to make. The banking crisis has shown that there can be a conflict between decision-making about money and making sure everyone follows the rules.

It's possible that central bankers have been around politicians so much that they don't want to take the blame for unemployment going up. Even though they might be independent according to the law, they're not the unbiased rulers everyone thinks they are. They can see how their actions can cause problems for people and they try to avoid that while also trying to keep inflation low.

It is a good thing that central bankers prioritize the well-being of the people they are serving. However, this implies a tendency to lean towards inflation. Therefore, it is important for economic policymakers around the world to read King's book without hesitation.

Let's Discuss Inflation: Reflections from the Last 2,000 Years is a book authored by Stephen D King, available for purchase at the cost of £20 for 224 pages. The book highlights 14 critical lessons on the topic of inflation.

Nicholas Macpherson used to hold the position of permanent secretary at the United Kingdom's Treasury.

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