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First it was rental cars, then building materials. Then it was housing, food, petrol. We are experiencing price rises not seen since the 1970s, or at least since the introduction of the euro, as we used to complain. First, we tried to talk it down. It will be ‘transitory’, was the catchphrase. Then, to avoid acknowledging the obvious, we fiddled with the benchmarks and started to observe only ‘core’ prices, mean prices, median prices, ‘adjusted’ prices, two-year averages, or argued with a basket of goods nobody wished to buy anyhow.
However we sliced and diced price monitoring – all readings now point steeply upwards. Our hope that all those drastic price increases were only temporary has been frustrated. We have reached a point where commentators, bankers and professional investors are not buying it anymore. They expect central bankers to step in, better early than too late.
Monetary authorities are in a bind. If they reduce liquidity now and raise interest rates, they will throttle an economy which is only hesitantly recovering from the biggest downtime since the 1930s Great Depression. If they don’t, markets will interpret such inaction as wilful neglect of its duty to price stability. Investors will then take inflation as a given and may start selling bonds and currencies at random, thereby forcing interest rates up in panic.
This is why the central banks of Norway, New Zealand, Canada and the UK have already indicated their willingness to start raising interest rates sooner than initially thought necessary. The US FED, the world’s most relevant central bank, and the ECB may have to follow suit.
The tools available to force inflation down are crude and limited. Central banks can shrink their balance sheets selling bonds they have acquired during the Great Financial Crisis of 2009 and again since the COVID-crash of 2020. This will reduce the amount of money in circulation. And they can hike interest rates. Both will make credit harder to come by, both for consumers and business, thereby throttling economic activity.
Consumption will drop and business will have to scale back. The resulting recession will bring prices down eventually. The efficacy and the pain of such action were proven convincingly by the late Fed governor Paul Volker, who in the 1980s brought inflation successfully under control.
The ills Volker tried to cure so radically, with interest rates reaching 20 per cent and more, were specific for the 1970s and 1980s and hardly a blueprint for today. Explosive energy prices triggered by OPEC’s oil embargo had fed through the value chain. Pampered by continuous, uninterrupted after-war growth, workers and businesses tried to outsmart each other.
When prices went up, labour demanded compensation, which in turn led to higher prices and new wage demands. Inflation was in a seemingly unstoppable upward spiral. Labour still wielded bargaining power then, which globalisation has debilitated.
This was the time when the idea of ‘inflation expectation’ came in focus, meaning that people experiencing ever higher prices will start to adapt their behaviour accordingly. Most consequentially, this would mean to buy stuff rather now than tomorrow no matter how expensive, thus accelerating inflation even more. I do not know if ‘inflation expectations’ ever existed outside hyper-inflationary countries like Zimbabwe or Venezuela. But, as an economic theory, it was illustrative and helped to justify Paul Volker’s bloodletting.
Today’s price spikes are a reaction to unexpected and incalculable scarcity, not unbridled demand- Andreas Weitzer
On the face of it, the price shocks we experience today are reminiscent of the 1970s. Energy prices, particularly for natural gas, have multiplied. Everything, from materials to spares, from transport to foodstuff, gets more expensive by the day and forces businesses to charge ever higher prices which consumers seem happy to accept. Wages are offered with a generosity not seen for decades. Surveyed, consumers ‘expect’ worse to come.
Yet, there are still far fewer people employed than before the onset of the pandemic. Consumer demand for services and goods, while returning with vehemence, has still not caught up with pre-crisis trends. Prices are out of joint not because we buy too much but because supply is in disarray. Similar to our panic buying during lockdown (see my piece about loo-roll economics from September), businesses are panicking in the reopening. With demand back on, they found their warehouses empty and their suppliers unprepared.
Transport congestion was the starting point. Containers were not where they were needed most, stranded at the wrong places as the economy had ground to a halt. Shipping was slow to recover, with ports paralysed and freight rates sky-rocketing. Input was hampered by missing spares and suddenly hard-to-come-by materials.
A good example is the deficit of microchips, handicapping the production of everything, from cars to fridges to cell phones. As congestion intensifies, so does contagion. Who would have thought that the supply of fizzy drinks and poultry can suffer from a slowdown in fertiliser production?
The other sticking point is labour. As it seems, even generous pay offers cannot persuade people to go back serving drinks, cleaning rooms or driving trucks. Open job offers in most countries by far exceed the number of jobseekers. But exorbitant offers should not be confused with pay rises demanded by workers. Employees do not yet bargain for higher salaries. They are stunned by a life-changing experience and still do not know what to make of it.
Social media tell about miraculous riches amassed by crypto and meme stock traders. Friends, colleagues and family still get infected with COVID. Childcare is still difficult. And the old employer who made one redundant without blinking is certainly unacceptable.
The inflation we thus experience is caused by supply haemorrhages and deficit bidding, not galloping consumer demand. Consumers have admittedly postponed purchases during lockdown, paid down debt and increased savings, thanks to generous transfer payments. They sit globally on trillions of unspent money.
Yet there is nothing to indicate that households are splashing it out. Anecdotal evidence suggests that consumers are more cautious than in the past. And then, empty shelves, missing merchandise and unknown delivery times are hardly supportive of binge buying, even for the most reckless spender.
Central banks are not well equipped to handle supply-side inflation. Making credit more expensive will not produce more microchips, more containers or more barrels of oil. Nor will it procure more workers. Manufacturers are already handicapped by those and other supply shortages. More expensive credit will not stop businesses from fighting for supplies.
Both consumers and producers have enough cash savings to sit out higher interest rates for longer. For them to noticeably respond, credit conditions have to be tightened to such an extent that all previous measures to alleviate the hardship of lockdowns would be wasted.
Supply issues will get much worse until they get better. Today’s price spikes are a reaction to unexpected and incalculable scarcity, not unbridled demand. Once supplies are sorted, orders will go into reverse. China – slowed down by its energy crisis, real estate crisis, materials crisis, unemployment crisis and new outbreaks of COVID – will put brakes on our economies faster than we can fathom. Interest hikes will then look ill-timed. The best action central banks can therefore take is to talk the talk and never walk the walk.
