My opinion: the inflation bug is blocking the recovery

The inflation scarecrow has been rekindled in discussions about the outlook for the global economy. Questionable economic progress before the pandemic, fiscal constraints and vaccine apartheid were bad enough. Clearly anti-inflationary measures now also threaten recovery and sustainable development.

The International Monetary Fund (IMF) has downgraded its latest global growth forecasts. Its latest World Economic Outlook (WEP) warns of a “dangerous divergence” between richer and poorer countries. This has been exacerbated by – but also worsened – national tax disparities and the “great vaccine divide”.

The inflation bug is revived

In addition, there is more and more talk of stagflation, that is, rising inflation with slow growth and high unemployment, as in the 1970s. Meanwhile, The Economist warns against Harmful “wage-price spirals” which aggravate the vicious circles of rising inflation and wage demands.

But more than 70%, or 152, of the 209 economists surveyed believe that the rise in inflation around the world is due to temporary disruptions in the supply chain. The heads of major central banks, such as the US Federal Reserve, the Bank of England and the European Central Bank, agree.

While the IMF agrees, it also urges policymakers to “be vigilant and ready to act, especially if … output gaps [materialise]”.

The IMF’s October 2021 Budget Observatory urges governments to take all necessary measures to regain the confidence of capital markets and lenders, including reducing budget deficits. But he also warns against “self-destruction” premature elimination of necessary remedial measures. Thus, the “two-handed” economists of the IMF offer contradictory political orientations.

Wrong diagnosis

But inflation is unlikely to persist. First, the deregulation of the labor market since the 1980s has long eroded the bargaining power of workers. As a result, workers are now more concerned with job security, which has lost ground in recent decades.

Second, the creation of “decent” jobs remains weak in most rich countries after decades of outsourcing and labor-saving innovations. It is therefore not surprising that the share of labor in national income has been declining since the mid-1970s.

While employment is generally lagging behind the recovery, the current lag is “larger” than before, notes the IMF. Around the world, labor force participation and employment remain well below pre-pandemic levels, especially for young people.

The WEO notes that private investment fell in the second quarter of 2021, with several new responsible uncertainties. Slower investment and growth also means less tax revenue and higher debt-to-GDP ratios. Cutting back on spending will only make it worse.

Correct diagnosis should be the basis for the choice of the drug. Contrary to monetarist belief, inflation is not just due to excess money supply. But if supplies are blocked – for example, due to disasters, conflicts, curfews or transportation restrictions – demand easily becomes “excessive”.

Inflation is often also due to large suppliers abusing their market power, with powerful companies raising prices with higher margins. Privatization and deregulation over the past four decades have strengthened these monopolies or oligopolies.

Blunt instrument

The WEO seems more concerned with inflation than jobs as financial markets demand monetary tightening, interest rate hikes and fiscal austerity. Bloomberg urged emerging economies to “prepare for rate hikes,” with Mexico, Brazil, Peru, Russia and others forcing, as The Economist had predicted.

The interest rate is a blunt tool. Inflation is reduced by raising interest rates, reducing growth and increasing unemployment – “hard medicine”, indeed. The Falcons point out how inflation erodes the purchasing power of the poor, but deny that their prescriptions make it worse.

The other question is how interest rate hikes are supposed to solve the real problems. For example, in September of this year, global food prices climbed almost 33% year on year due to extreme weather conditions and pandemic restrictions. Higher rates certainly couldn’t help when a severe drought hit hydroelectric power generation in Brazil.

Higher interest rates squeeze private and public spending. Thus, rate hikes are likely to trigger a vicious cycle of further rate hikes and general austerity, slowing the recovery and increasing debt-to-GDP ratios.

Rising interest rates in rich countries will also cause capital flight from developing countries and depreciate exchange rates. Already crippled by vaccine inequality and limited fiscal space, compounded by modest debt relief and pandemic support from rich countries, rising interest rates will push them back further.

Debt misinterpreted

Rising debt levels have naturally been a constant concern. In 2019, the World Bank warned that debt after the global financial crisis (CFM) was dangerous, noting that all previous waves of debt had ended in crises.

With the pandemic, fears are reviving of “catastrophic” debt crises in developing countries. As if governments have many choices, the Wall Street Journal warned, “Governments around the world are gorging themselves on record debt, testing new limits.”

The IMF’s October Fiscal Monitor acknowledges that “there is no magic number for the debt target. Macroeconomic theory does not prescribe a specific debt target; nor is there a clear threshold above which debt could become particularly damaging to economic growth ”. This confirms earlier findings from the IMF and World Bank suggesting exaggerated debt constraints.

The focus should instead be on “the likely growth effects of the level, composition and efficiency of public spending and taxation”. Instead of focusing on aggregate debt levels, its composition – internal versus external, public against state guarantee – deserves more attention.

In fact, debt-funded infrastructure, education, skills development and retraining programs all promote growth. IMF research has found that such infrastructure investments have significant effects on growth without even increasing the debt-to-GDP ratio.

Well-established challenges

The predictable recommendation is to tighten one’s belts – via austerity and higher interest rates – resulting in further economic contraction. Typical prescriptions for structural reforms – for example, further labor market liberalization, deregulation, privatization and tax cuts – only make matters worse, while regressive tax cuts rarely generate growth. promised.

The financialization of recent decades has further encouraged speculation, share buybacks, real estate bubbles, mergers and acquisitions. As a result, the real economy has suffered, with inflation rising as productivity growth weakens.

But inflation was brought under control by cheap imports and cheaper labor, even as profit margins and executive salaries increased. But neoliberals did not hesitate to take credit for bringing inflation under control during the Great Moderation through fiscal austerity, debt ceilings and inflation targeting.

Despite fiscal austerity, debt has increased, especially since the GFC. Slower growth has also translated into lower revenues, further reducing fiscal space. Cuts in public investment, especially in services, infrastructure, research and development, have also hurt productivity growth.

Build forward, not back

Every economic crisis is different in its own way. The Covid-19 recession involves both supply and demand shocks. Production fell due to blockages and disruptions in the value chain. Demand has also declined with lower incomes, less spending, more jobs lost and greater uncertainty.

When provided, relief measures have supported some demand. Pandemic restrictions have accelerated digitization, but other changes are also needed. Reforms must build on the transformations of Covid-19 for a better future, for example, by promoting job-intensive green investments, requalification and retraining of workers.

The Covid recession thus offers an unexpected opportunity to “build better” to tackle deep problems to build a better world. This must necessarily involve getting rid of skewed and dysfunctional arrangements, managing markets, directing private investment, retraining the workforce, and investing in education, health and social protection.


Anis Chowdhury, former professor of economics at the University of Western Sydney, held senior positions at the United Nations from 2008 to 2015 in New York and Bangkok. Jomo Kwame Sundaram, former professor of economics, was United Nations Under-Secretary-General for Economic Development. He is the recipient of the Wassily Leontief Award for Advancing Frontiers in Economic Thought.

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