Prices are rising by 5, 6, 7 per cent per annum. In the US, President Joe Biden is under pressure over the increase in petrol prices. In the UK, there is talk of a cost-of-living crisis. The Bank of England is prescribing “tough love” in the form of steep interest rate rises. The Bild-Zeitung, Germany’s savage tabloid, pillories Europe’s central bankers for being careless about inflation. Bond markets are jittery.
It comes as a shock. Not so long ago, in large parts of the world, the main worry was not inflation but deflation. Now, even Japan – the poster child of “lowflation” since the 1990s – is experiencing price rises.
Whether prices go up or down, any change creates winners and losers. We worry about falling prices because they penalise those who have borrowed. Housing markets are spooked by even a hint of negative equity. Inflation, on the other hand, erodes savings and increases the cost of daily necessities.
In principle, economists tell us, we should welcome price changes. They are how market economies adjust to shocks, and Covid has certainly delivered a shock. It is one of the foundational ideas of neoliberal economics, classically formulated by Friedrich Hayek in his essay “The Use of Knowledge in Society” (1945), that prices are highly condensed vectors of information. Consumers and businesses don’t have to know much about what is going on, all they have to do is to respond to price signals. If prices go up, consumers demand less and producers supply more. That is the magic of market economies as super-efficient information-processing machines. Most recently, Philipp Hildebrand, vice-chair of the gargantuan asset manager BlackRock, has pleaded for central banks to tolerate inflation, because it “helps to smooth the adjustment to big shifts in patterns of demand”.
But Hayek’s vision is an idealisation, a vision of how prices “ought” to function if the existing structure of markets is taken as given, people confine their view of the world to economic signals and those signals send an unambiguous and simple message. In practice, as we are seeing, when a lot of prices adjust by a large amount in a short space of time, they deliver a lot more than an efficient signal. What we receive is more akin to an information bomb.
What is going on? Interpretations run wild. Is this merely a transitory shock or are we experiencing a general inflation in the economist’s sense? Is this a power-play by profiteering big business? Must the poor simply suffer? Are we about to witness an explosion of social tension? Or is this kind of inflation something uncanny, perhaps even entirely new?
Not for nothing, price increases often trigger social and political upheaval. It is hard to think of any major revolution that was not preceded by inflation and “bread riots”. Most recently, the protests in Kazakhstan and Lebanon were driven by sudden price shocks. We in the West are nowhere near that level of tension, but even affluent societies are feeling the strain. Memories of the gilets jaunes protests are fresh in the minds of the European elite and the embarrassingly skewed experience of the Covid crisis has sharpened awareness of class inequality.
In the response to the price surge, central banks are first in the firing line. They are responsible for preserving “price stability”. That does not mean that all prices remain fixed, but rather that the overall price level should not rise by more than a certain amount – generally 2 per cent per annum. But that begs the question: what actually is the “general price level”? Normally, it is represented by a suite of statistical indicators, price indices that track baskets of goods – consumer prices, producer prices, or the deflator for GDP, an index of all the prices of goods and services that go into total production.
Broad-based price indices give us an approximate indication of the purchasing power of money. That is what economists mean by inflation. Not particular price movements. Not a movement of prices relative to wages. But a movement of the price of all goods and services relative to the economy’s common denominator, which is money. This is the tautological sense in which the monetarist guru Milton Friedman could pronounce that inflation is “always and everywhere a monetary phenomenon”. And this is why, understood in these terms, inflation-control is the responsibility of the central bank as the agency in charge of managing the supply of money and credit. Ensuring price stability means that there will be no runaway devaluation of money.
Economists can give lots of reasons why rapid inflation is bad for economic activity in general. Changing prices and wages all the time is inefficient. It leads to uncertainty that hampers investment. It makes it difficult to distinguish changes in relative prices – the signals that Hayek was celebrating – from the background noise of general inflation. But above all it is a distributional question. Substantial inflation eats away at the value of those assets that are denominated simply in money. Shares are relatively well protected against inflation because they pay a fraction of profit in dividend. Profits will generally rise with prices. The same is not true of bonds. Though they are the less headline-grabbing segment of the financial markets, there are more bonds in circulation than shares. And the biggest bond market of all is that for government debt.
Over $20trn dollars are outstanding in the US, close to $3trn in the UK. Because the real value of a bond and the interest that it pays depends on the price level now and decades into the future, the bond market is highly sensitive not just to actual inflation but also to expected inflation as far as 10 years from now. Bond markets have been on a hair-trigger over inflation since the autumn, when prices began to accelerate. Central banks don’t want investors to dump bonds and drive up interest rates, choking the economy. To avoid that outcome, the central banks are easing interest rates up themselves and promising to hold inflation in check, and so calming investors.
This is always a delicate operation. The risk is that the central bankers themselves throttle the economy. They must raise rates by just the right amount. Not too much and not too little. To calibrate their choices, the central bankers eagerly scan every release of new inflation indices, while the markets watch the central bankers watching the data. Nerves are on edge.
[see also: Why inflation could break Britain]
This drama of inflation, central bankers and bond markets is gigantic in scale and global in scope. But it is also dominated by technical expertise, and remote from everyday experience, at least until it results in rising credit card and mortgage interest rates. As a balancing act between “the general price level”, money and bonds it has, necessarily, an abstract quality. These are the classic questions of macroeconomics.
But part of the perplexity of our present post-Covid moment is that macroeconomic categories do not capture what is going on very well. So far, it is still an open question whether the price increases we are experiencing really qualify as a sustained, general inflationary burst, rather than a set of discreet and distinct adjustments in sectors badly affected by the shock.
In most parts of the world, although most prices are rising by some amount, the main movement in the price indices is still being driven by a small number of goods. In the US it’s cars – due to the semiconductor chip shortage – energy and groceries. In the eurozone and the UK, energy is the key factor.
This poses two questions. Will the inflation remained confined to a limited number of sectors or, driven by wage increases, will it widen and become a truly general inflation? The most worrying possibility is the idea of future inflation becoming entrenched in the expectations of firms and workers, thus resulting in a prolonged phase of price increases that could only be countered by a serious toughening of central bank policy.
If, on the other hand, the price increases stay contained within certain sectors, rather than taking the market signal at face value, we are compelled to ask more searching and ultimately more political questions. Why are certain prices going up more than others. Is it a matter of corporate power? Are businesses profiteering? Why has the price of Covid tests in the US been allowed to surge? Why does meat suddenly cost more? Are the prices for discount food options rising more rapidly than branded goods? Who are the “guilty men” (and women)?
If we judge the price increases to be excessive, what are we to do about it? Central banks aren’t well equipped to deal with sectoral price increases. It does not seem likely that raising interest rates can help with a shortage of microchips, or the price of gas. Mistaking idiosyncratic shocks for a general inflation and responding with stringent monetary policy could have huge costs in terms of unemployment and low investment.
These questions have triggered numerous calls for governments to consider using price controls to tame inflation in particular markets. That is anathema to free-market economists. And even those supporting the idea must concede that implementing controls would require a government machine and a system of regulations that could exercise market oversight and discipline. Such bureaucracies do exist. Across Europe, it is estimated that 10 to 15 per cent of prices are regulated. But can such regulations be expanded to meet the current inflationary shock? When it comes to the price of budget food options in Britain, it is not clear that the ONS or anyone else even has a systematic method for keeping track.
The truly common denominator in inflation across the world now is energy prices. And the supply price of energy is not something that the governments in consumer countries have much control over. The exception is America, with its geopolitical clout. The Biden administration has publicly called for the “Opec+” group of oil-producing nations to increase its deliveries of oil and gas. The problem is not so much Opec, but the “+”, which refers to Russia, the world’s third-biggest oil producer and Europe’s major supplier of gas, which is involved in an escalating confrontation in Ukraine and under threat of US sanctions. To forestall a devastating price spike if that horror scenario comes true, Washington has opened negotiations with Qatar to increase its LNG deliveries to Europe.
That is one way of trying to contain gas prices. But in climate policy terms it is the opposite of what is needed. In addressing the climate crisis economists, following Hayek’s logic, overwhelmingly agree that we should be raising carbon prices. This sends the signal to consumers to reduce demand and to producers to reduce their use of carbon-intensive fuels such as coal. The UK and EU have successfully introduced minimum carbon prices and emissions trading to raise the cost of CO2 pollution. As the price of gas, the cleaner fossil fuel, has surged, so too has the price of emissions certificates that generators need to buy if they want to use coal. That is what the system is intended to do. It is sending the right signal. The question is, can we live with it?
It is at this point that the inflation problem and the structural adjustment problem become a cost-of-living crisis. Encoded in prices and wages are not just the value of money relative to goods and the balance of supply and demand, but the entire hierarchy of inequality, privilege and class. We navigate this hierarchy every day as a matter of course, when we choose which supermarket to shop in, what car to buy, where to have our hair cut. But we feel it most acutely when relativities shift. At one end of the scale, London’s struggling upper-middle-class finds itself outcompeted for places at exclusive private schools by Russian oligarchs. For those scraping by on minimum income the real risk is that sanctions on Vladimir Putin’s Russia will leave them unable to afford their gas bills. It is a question of suffering. People will literally freeze as a result of energy poverty. Some will die. In hot places, the same will happen in the summer if air-conditioning is too expensive. The value of life is part of the information encoded in prices, normally in a way that allows us to ignore its uncomfortable implications.
Exposing these hierarchies, bringing the real cost of living for those at the bottom of the income pyramid into public consciousness, has been the object of social investigators and activists since as far back as the early 19th century and the beginning of urbanisation and the Industrial Revolution. Jack Monroe’s campaign to force the cost of living for the poorest in British society to the top of the agenda is a remarkable revival of this tradition. And these kind of tactics have real force. As energy prices have surged, the UK, Spain and the Netherlands have put price caps and subsidies and other relief measures in place. Rather than creating a new and general system of price controls, which would involve real state-building, or addressing the root causes of inequality and poverty, they are patching up a social crisis.
So acute is this sense of shamefaced solidarity that otherwise confident pundits have declared it insensitive to even speak of transitory inflation, given the evident pain felt by low-income households. The Covid-inflation scare has forced the language of central banking and macroeconomics into an uncomfortable face-to-face with the discourse of the cost-of-living crisis. It is a jarring encounter. What does the cost of living for the very bottom of the income distribution have to do with inflation as understood by central banks? It’s an open question. Economists and statisticians are scrambling to answer Monroe’s challenge. In the meantime, advocates of social justice should beware false friends among the anti-inflation hawks. There is a long tradition of exploiting feigned concern for the “little people” in order to further conservative economic policy.
Protests over price increases, whether by social activists or indignant van drivers, may stir the political system. But as guardians of price stability, what concerns central bankers far more is working people’s efforts to do something about the rising cost of living by demanding price increases of their own – namely an increase in the price of labour.
When we report record levels of inflation we are engaged in more than an accounting exercise. Statistical time series evoke history. Among economic policymakers, what hangs over the present is the memory of the 1970s and the fear of the so-called wage-price spiral, in which, driven by trade union power, wages chased prices upwards. Unlike calls to limit price increases through administrative regulation, collective wage bargaining poses the question of social power directly. And it exposes more puzzles and unspoken assumptions at the heart of the seemingly simple idea of price adjustment.
Strictly speaking, an inflation only in the price of goods and not in wages should not meet the economist’s definition of a true, general inflation, which makes no distinction between goods and services, workers and capital. The wage is just the price of labour. A price inflation without a wage adjustment simply means that the wage share is squeezed: a result that employers will generally applaud. A wage-price spiral terrifies policymakers and investors precisely because it suggests a balance of power. If wages do go up, it implies that workers have enough power to demand wages in line with rising prices. The losers are the holders of money assets. And at that point, it becomes clear that the value of money is part not just of the economy but of the power structure that encases it.
As a result, just as there is no Hayekian adjustment of individual prices without the possibility of conflict, there is no general inflation of all prices without conflict either. Periods of rapid inflation have tended historically to be periods of class conflict. And the influence runs both ways. Not only can trade union power be a driver of price increases, but an inflationary surge increases the incentive for workers of all kinds to join trade unions in order to gain bargaining power. This was true both in the early 20th century, the moment of maximum class unrest around the First World War, and in the 1970s when white-collar unionism took off.
To think of the wage-price relationship, what the economists call the Phillips curve, as an objective fact that you discover by statistical methods is to miss the point. In fact, it is something that is made by social action. And for that reason, in 2022 a wage-price spiral seems more the stuff of central banker nightmares than a likely outcome. Admittedly, there was an uptick in labour militancy in 2021. In the US, worker bargaining power has increased thanks to Covid. But to imagine this spiralling into a generalised shift in the power balance is far-fetched. In the UK in 2022 real wages – wages adjusted for price inflation – will likely fall, as they did in the US in 2021. The pandemic is not jolting us back to the 1970s any more than the lockdowns jolted us back to the social contract of 1945.
Class relations were irrevocably transformed by globalisation and the neoliberal shock of the 1980s and 1990s, ruling out the prospect of an active wage-price spiral. The Covid shock to the pattern of demand and production will likely prove transitory. The hive-mind of the bond markets is surely right. Inflation will stay high for a while and then subside. Central banks will do enough to prevent a general outbreak. The thing about transitional periods is that you do have to pass through them. Promoting the idea of a sustained 1970s-style escalation is either scaremongering or wishful thinking – a reflection of hopes and fears about inequality and class struggle rather than a realistic expectation of the future.
But though Covid-inflation is likely to be transitory, that does not mean that the shock itself is historically inconsequential. Covid was not, after all, merely an exogenous shock to which markets allow us to adjust in a more or less Hayekian fashion. It was a warning, a harbinger of a more uncertain and disrupted future. The most likely scenario is that the virus becomes endemic, with an unpredictable stream of new variants provoking smaller but recurring seasonal outbreaks. The feckless failure to enact a sustained global vaccination campaign makes that prospect even more likely. And without a far-reaching adjustment in food chains and patterns of global development, and comprehensive precautions, Covid will just be the first of many viral challenges to come.
Pandemics are perhaps the most general and fast-moving threat we can imagine. But extreme climate events will bring disruption to oil fields and pipelines. Drought and spikes in temperature will produce harvest failure and unpredictable surges in food prices. And, as we move to comprehensive reliance on wind and solar energy, we will have to contend with the variability of the weather far more than we are used to. All of these will deliver one “idiosyncratic” economic shock after another. The price system will still contain useful information, but we will have to develop a new intelligence in deciphering its meaning. We may need to consider a new range of fiscal and monetary tools with which to react. If Covid was the first comprehensive economic crisis of the Anthropocene, then we still have a lot of learning to do.