Modern Monetary Theory (MMT) economists have argued from the outset that using interest rate rises to subdue inflationary pressures may in fact add to those pressures through their impact on business costs. Businesses with outstanding trade credit or overdrafts will use their market power to pass the higher borrowing costs on to consumers. In more recent times, we have seen other mechanisms through which central bank rate hikes actually add to inflation. Regular readers will know that I have been discussing how landlords have been passing on higher mortgage costs in tight rental markets, which then creates a vicious cycle – interest rates up, rental costs up, CPI up because rents are a significant component, inflation rises, interest rates rise. Repeat. The tight rental markets are in part, a consequence of the neoliberal austerity bias, which has seen governments seriously underinvest in social (low income) housing. In recent days, we have witnessed another conflation of neoliberalism and destructive policy insanity. Earlier this month, Australians received messages from the companies that provide them with electricity announcing that the Australian Energy Regulator (AER) had approved price rises of between 19.6 per cent and 24.9 per cent in various East coast states. How did that happen, especially as world coal prices are dropping rapidly and are now below the pre-pandemic levels? And how does the bias towards monetary policy exacerbate this situation?
Yesterday’s US inflation data from the Bureau of Labor Statistics (July 12, 2023) – Consumer Price Index Summary – June 2023 – shows a further significant drop in the inflation rate as some of the key supply-side drivers continue to abate. The annual inflation rate is now back to 3 per cent and dropping fast. The risk now is that the conduct of the Federal Reserve will drive the US into a deflationary period with rising unemployment. Given that inflation peaked in the third-quarter 2022, that wages growth has been relatively subdued, and inflationary expectations’ survey evidence suggests no-one really thinks the inflation was going to endure, means that the US Federal Reserve’s logic is deeply flawed and not fit for purpose. They have been chasing an obsession that exists in a parallel universe to the real world. The risk is that they will continue to chase that obsession and use the fact that unemployment has still not risen much to claim there has to be higher unemployment. However, hopefully, the 3 per cent inflation rate result yesterday will cut-off any wild claims that they have to get the inflation down more quickly or risk a wages or expectations explosion. All cant of course.
Recently, I wrote about the conditions that dictate what impacts interest rate changes will have on aggregate spending and demand-driven inflation in direction, magnitude and temporality – see RBA governor’s ‘Qu’ils mangent de la brioche’ moments of disdain (June 8, 2023). It is highly likely in many cases, the decisions by central banks to increase interest rates, ostensibly to ‘fight inflation’ actually make inflation worse. More people are starting to understand that point even though central bankers appear to be still talking big about further interest rate rises. But the evidence is mounting against their position and ultimately that evidence is exposing the deep flaws in mainstream macroeconomics. I argue today that the problem is not only that the interest rate hikes can be inflationary but they are also facilitating a major reinforcement of the class divisions in our societies whereby the low income cohorts are transferring massive income benefits to the higher deciles. I also discuss cricket which recently has provided a demonstration of how the class divisions work. Then some music, given it is a Wednesday.
In the 1890s, industrial capitalism had reached the point where the pain inflicted on workers in search of private profits by the industrialists reached a point where the workers could no longer tolerate it and they started to realise that in unity they had strength. This was a period of major industrial disputes and a burgeoning of trade union growth beyond the previously restrictive craft union base. The development of broad-based unions and their move into the political domain to give further voice to the concerns of workers marked a turning point and fostered social democratic political movements and the spread of welfare state capitalism, which lasted until the 1970s. The neoliberal period has seen many of the gains made by workers during that period wound back and now we are witnessing the consequences of that retrenchment – massive real wage cuts, profit gouging and central banks determined to further undermine the well-being of workers as they attempt to push up unemployment, in the name of fighting inflation. An inflation that is persistent only because corporations are using this period to solidify the shift in income distribution towards profits at the expense of wages. It is also apparent that the trade union movement has become co-opted and now collaborate with government and corporate bosses to oversee the deliberate cuts in real wages of their members. This is another turning point in history, where the workers’ own representatives give their support to policies that support those cuts, under the pretense that they have to be responsible. Responsible to whom? We are in a defining period at present in the class struggle and it seems that the labour side has swapped teams.
Today (June 28, 2023), the Australian Bureau of Statistics released the latest – Monthly Consumer Price Indicator – which covers the period to May 2023. On an annual basis, the monthly All Items CPI rate of increase was 5.6 per cent down from 6.8 per cent. There is some stickiness in some of the components in the CPI but overall inflation peaked last year and is now declining fairly quickly as the factors that caused the pressures in the first place are abating. I doubt that any of this decline is due to the obsessive interest rate hikes by the Reserve Bank of Australia. Anyway, a quick analysis of the data then some discussion of the British teachers’ pay dispute, the latest Australian Covid numbers (worrying) and some music to cheer us all up after the economics. The overwhelming point of today’s data is that this period of inflation is proving to be transitory and did not justify the rate increases. It was a supply-side event and trying to increase unemployment to kill off spending (demand) will just leave an ugly legacy once those supply-side factors abate (which they are and were always going to).
Last week – RBA wants to destroy the livelihoods of 140,000 Australian workers – a shocking indictment of a failed state (June 22, 2023) – I wrote about the sense of being in a parallel universe when one reads official statements from the Bank of Japan and juxtaposes them against the stream of statements coming out of other central banks. The day after I wrote that post (June 23 2026), the Japanese e-Stat service (the portal for Japanese government statistics) released the latest – Monthly CPI data – which showed that the annual inflation rate fell by 0.2 points to 3.2 per cent in May, on the back of significant easing in electricity and gas prices, in part the result of government policy aimed at reducing energy prices rises in the domestic economy. Here is some more about the parallel universe. I conclude that the experiment underway between central banks is indicating that Japan’s zero interest rate regime (with fiscal expansion) is not an inflationary factor. It has not driven dangerous shifts in inflationary expectations for businesses or households. Further, the decision by the Bank of Japan not to hike rates has reduced the cost-of-living squeeze on mortgaged households that is being imposed by the (transitory) inflationary pressures. By way of contrast, other central banks have imposed extra burdens on those with debt and are engineering a massive redistribution of income from poor to rich into the bargain. As they continue with their blindness, they are risking recession and a major rise in unemployment, which will add to the pain the citizens are enduring.
My early academic work was on the Phillips curve and the precision in estimating the concept of a natural rate of unemployment, or the rate of unemployment where inflation stabilises at some level. This rate is now commonly referred to as the Non-Accelerating-Rate-of-Unemployment (NAIRU) and my contribution was one of the first studies to show that the rate was variable and went up and down with the economic cycle, rendering it a meaningless concept for discretionary policy interventions. I extended that work into my PhD and built on much earlier work as a undergraduate to articulate the Job Guarantee idea. The NAIRU is unobservable and there have been various ways to estimate it from actual data. The problem is that these estimates are highly sensitive to the approach – so two researchers can get quite different estimates using the same data. Further, the estimates themselves are subject to large statistical errors meaning that we cannot be sure whether the NAIRU is say 4.5 per cent or 3.5 per cent or 5.5 per cent, say. Such imprecision makes it impossible to use the concept as a guide for monetary policy because if the NAIRU actually existed then ‘full employment’ might be at 3.5 or 5.5 per cent today but next week the estimates might be even wider. When would one want to start changing interest rates in pursuit of inflation stability – when the actual unemployment rate was down to 3.5 per cent or at 5.5 per cent or somewhere in between or at higher or lower unemployment rates, depending on what the models pumped out? You can see the problem. For some years, central bankers went quiet on the use of the NAIRU and stopped publishing their estimates exactly because they knew full well about the imprecision and that policy based on such a vague, difficult to estimate, unobservable would be discredited. That is until now. The RBA is now clearly admitting that their damaging and unnecessary interest rate hikes over the last year and a bit have been driven by the NAIRU. A sham. But a tragedy as well given the RBA’s almost obsession with pushing unemployment up by around 140,000. A shocking indictment of where we have reached as a civilisation.
The RBA governor had a few ‘Qu’ils mangent de la brioche’ moments in the last week when he responded to criticisms that his manic interest rate increasing behaviour is driving low-income families into crisis by, first, saying that people who couldn’t find cheap housing should move back with their parents. Then he followed that with the recommendation that people should work harder and get second jobs if they couldn’t make ends meet as a consequences of the squeeze on their mortgage payments from the RBA’s monetary policy changes. Nice. This is an extraordinary period of policy chaos – we have an out-of-control central bank pushing rates up and using various ruses (chasing shadows) to justify the hikes, when inflation is falling anyway for reasons unconnected to the monetary policy shifts. All the RBA will succeed in doing is increasing unemployment and misery. The unemployed will ultimately bear the brunt of this chaotic policy period. But then ‘Qu’ils mangent de la brioche’ and they can move back in with their parents!
As the inflation episode starts to abate, central bank governors have been keen to advance narratives to justify why they would continue hiking interest rates, especially when it is pretty obvious that the drivers of the inflation were mostly coming from the supply-side and suppressing aggregate spending (via the higher rates) would not be a very effective measure to deploy. This is quite apart from the debate as to the effectiveness of using interest rates to stifle spending, which is a separate discussion with no clear conclusion other than probably not. As I have noted previously, it was hard to argue that inflation was accelerating out of control when it had started to decline many months ago. So they had to come up with a different narrative – which was that while inflation was falling it was not falling quickly enough. That is the current story line the officials trot out. And that allows them to claim that if it doesn’t fall quickly then two things will be likely: (a) workers will build the higher inflation into their wage demands and set off a wage-price spiral that becomes self-fulfilling even after the supply-side factors (Covid, Ukraine, OPEC) abate, and (b) that people would start to expect higher inflation was the norm and build that into the contractual arrangements and pricing. Neither behavioural phenomenon has shown any sign of becoming entrenched, which leaves the central bank officials without a cover. And even research from central banks themselves is demonstrating that there is not ‘high inflation’ mindset taking over.
It’s Wednesday and there is a lot going on in the data release sense – housing finance, construction and today, the Australian Bureau of Statistics released the latest – Monthly Consumer Price Indicator – which covers the period to April 2023. On an annual basis, the monthly All Items CPI rate of increase was 6.8 per cent down from 6.9 per cent. There is some stickiness in some of the components in the CPI but overall inflation peaked last year and is slowly declining as the factors that caused the pressures in the first place are abating. Tomorrow I plan to discuss an apparent tension in the Modern Monetary Theory (MMT) community as to whether interest rate increases are expansionary or contractionary. But today we just consider the data and then listen to some dub.