I’ve had some push-back on my column last week Inflation is always and everywhere a monetary phenomenon, there is no such thing as cost-push inflation. (desmondswaynemp.com) in which I argued that inflation is driven by the quantity of money rising faster than the goods and services available for it to purchase. As against material and production cost increases being passed on by the producers to consumers in higher prices.
As any producer or retailer knows, you can’t just pass on your additional costs to consumers in the expectation that they will pay-up. There will be a price that the market will bear, beyond which consumers will reduce their consumption and switch to other products. A retailer needs to consider whether a price increase will actually reduce his total revenue, because a reduction in sales might be proportionately greater than the increase in the price charged.
Any enterprise facing increased costs needs to consider whether those costs are worth incurring given the price that consumers are willing to pay, or whether it is better just to pack-up and do something else instead.
In a consumption driven economy like ours, when external factors (like war in Ukraine or the closure of strategically important ports in China due to Covid) send basic commodity prices up, consumers prioritise what they need to spend and reduce discretionary expenditure. Inevitably, there will be hardship and unemployment among the suppliers of those discretionary items.
Equally, workers -faced by higher prices, demand higher wages. Which, when granted, will reduce the demand for their labour resulting in further unemployment.
Such is our concern about unemployment that governments seek to generate additional demand in the economy, through increased public and private expenditure financed by credit (i.e. more money) in order to sustain full-employment at the higher level of prices. This is inflation: you need more money to buy the same amount of stuff; your money holds less value relative to what it can buy; Money, like anything else, is less valuable because there is more of it.
From the late sixties to the late seventies governments tried to control inflation by regulating prices and wages instead of dealing with the fundamental causes -which were their own policies of expanding the money supply in an attempt to cure rising unemployment.
Since the shock of the financial melt-down of 2008, governments have similarly stood by as central banks sustained economic activity through a new way of increasing credit (‘quantitative easing’). We enjoyed the party, but now we have the inflation hangover.
The whole world economy has endured the same oil and food price shock, but inflation differs in each developed economy according to the monetary expansion engineered over the last decade. Japan eschewed that policy; that’s why its inflation is only just over 1%.
We need stop drinking now, and recover from the hangover