Category Archives: Inflation

The Supercycle and MMT

I listened to a very good interview on the David McWilliams podcast in which he talks with Dario Perkins the super cycle and the end of neoliberalism. A lot of the discussion was around the paper that Dario Perkins had written – A New Supercycle Running on MMT – in which he sees MMT as delivering a superior fiscal-monetary mix.
The fact that fiscal policy must take over from monetary policy has been the apparent with the range of policies that were implemented after the GFC. Since the late-19th century the super cycle can be placed into three phases of Capitalism influenced by macro-financial-political regimes – see chart below. MMT could provide the intellectual rationale for a new form of capitalism – Capitalism 4.0. Over the last century the pendulum has swung between extreme fiscal and extreme monetary policy with the global economy primed for another change.

1920’s – Monetary policy dominated but ineffective during the Great Depression
1930’s – Fiscal policy dominated as there was a need for government intervention to get the economy moving after the Great Depression
1940’s – 1960’s – Fiscal Policy – with the 2nd World War and the recovery process post-war.
1970’s – Stagflation and fiscal policy is no longer effective and Keynesian economics as government spending just causes higher inflation and higher unemployment.
1980’s – Monetary policy gains traction and inflation is brought under control. Central Banks become independent and fiscal policy and government intervention is seen as a restriction to growth. With Reagan and Thatcher Neoliberalism was the ideology of the day

Source: A New Supercycle Running on MMT

Have we reached a new regime – Capitalism 4.0?
The GFC was a warning that capitalism in its present form was not working and there was potential for a new regime change. However governments adopted austerity and QE which made inequality worse. The issue was that there was no alternative to the neoliberalism Capitalism 3.0 but with the arrival of COVID-19 governments have been forced to spend up large and there is a belief that the old system doesn’t work and that maintaining Capitalism 3.0 will not make the situation any better. Stephanie Kelton, author of The Deficit Myth, argues that we need to rethink our attitudes towards government spending.

Modern Monetary Theory (MMT)
MMT states that a government that can create its own money therefore:Cannot default on debt denominated in its own currency;

  • Can pay for goods, services, and financial assets without a need to collect money in the form of taxes or debt issuance in advance of such purchases;
  • Is limited in its money creation and purchases by inflation, which accelerates once the economic resources (i.e., labor and capital) of the economy are utilised at full employment;
  • Can control inflation by taxation and bond issuance, which remove excess money from circulation, although the political will to do so may not always exist;
  • Does not need to compete with the private sector for scarce savings by issuing bonds.
  • Within this model the only constraint on spending is inflation, which can break out if the public and private sectors spend too much at the same time. As long as there are enough workers and equipment to meet growing demand without igniting inflation, the government can spend what it needs to maintain employment and achieve goals such as halting climate change.

It will be interesting to see if MMT can enjoy the same presence in economic policy that monetarism and Milton Friedman experienced in the post-stagflation time period. Back then there was a political revolution primed to embrace monetarism and neoliberal ideas and an electorate that had experienced a serious economic crisis – stagflation. Subsequently the influence of MMT will come down to politics.

Joe Biden seems to have embarked on a more radical macro-economic policy which has various instruments that are found in MMT. Will there be other political leaders who embrace this paradigm like Reagan and Thatcher in the 1980’s with Friedman and monetarism?

Source: A New Supercycle Running on MMT

The New Inflation Threat – Cost Push and Demand Pull – should we be worried?

If you are teaching macro policy this podcast from the BBC Business Daily programme is excellent. They debate whether inflation will be a short-term phenomenon or have a longer lasting impact on the global economy. It features Mohamed El-Erian, economic adviser and president of Queens’ College, Cambridge, who thinks central banks are already behind the curve when it comes to keeping inflation in check. Dana Peterson of the US Conference Board takes the view that it will be temporary. They also interview a restaurant owner Luke Garnsworthy. Now that England’s third lockdown has mostly lifted, customers are itching to spend and he can’t find enough staff for his kitchens. But, he says raising prices and wages isn’t an option for him. The key points from the podcast are below:

Demand Pressures
A year ago the global economy was in shutdown mode with no demand as consumers had nowhere to go. However with significant spending by governments to support those who have lost their job and the fact that people can’t spend has meant that there is a lot of pent up demand waiting to unleash itself on the market. Now that a lot of countries have opened up their economies, aggregate demand is surging and making up for lost time. This has been a surprise to many but something that is likely to continue especially in those countries that are able to contain the virus and vaccinate their citizens.

Supply constraints
Many supply chains have been slow to return to their pre-covid volume. Problems with containers, availability of container ships have made it very difficult for producers to access component parts, raw materials etc. Commodity prices, eg oil, are on the rise accompanied by semiconductor chip shortages and the Suez Canal tanker incident have caused both businesses and consumers to worry about rising prices.

Countries like Bangladesh, India and Vietnam are central to the global supply chain but the severe nature of the pandemic in these countries has added another bottleneck.

A further problem is the lack of available labour which has resulted in some firms increasing their wages in order to attract workers – Amazon and McDonald’s have done this. But higher wages are unlikely to compensate for structural unemployment – mismatch of skills – which has been very prevalent. In order to compensate for these increasing costs companies will be tempted to put up their prices.

But should we be worried?
Dana Paterson, chief economist at The US Conference Board, believes that the long-term threat of inflation is exaggerated. She suggests that prices are rising in areas that were very popular during the pandemic but as it subsides consumers will switch their spending to other areas that wasn’t possible during the pandemic – eg. bars, restaurants, movies, theatre etc.

The emergence of working from home should offset some of the minimum wages increases in some economies as employees can save on commuting costs and move to cheaper accommodation. Businesses can also save on office space and hire more workers from low-cost areas.

The rise of e-commerce has generated more competition and has helped to keep prices lower. International supply chains, outsourcing and the likely continued relative strength of the US dollar will work to keep prices down. The US Fed view higher prices as a healthy economy and want to see it rise above its 2% target before increasing interest rates. Also tolerating more inflation gives the Fed time to meet its full-employment mandate. There should be more concern about the type of inflation that becomes prevalent – asset price inflation. This is especially true in New Zealand.

Are we heading into Stagflation?

Currently teaching macro conflicts with my CIE A2 class and we have been discussing the late 1970’s and the stagflation period – see graph below. Since the days of stagflation in the US and UK in the 1970’s inflation has been the number one target for central bankers. The main cause of inflation during this period was the price of oil –

  • 1973 – 400%↑ – supply-side– Yom Kippur War oil embargo
  • 1979 – 200%↑ – supply-side – Iran Iraq War
Source: The Economist

US President Jimmy Carter’s attempts to follow Keynes’s formula and spend his way out of trouble were going nowhere and the newly appointed Paul Volcker (US Fed Governor in the 1970’s) saw inflation as the worst of all economic evils. Below is an extract of an interview from the PBS series “Commanding Heights”

“It came to be considered part of Keynesian doctrine that a little bit of inflation is a good thing. And of course what happens then, you get a little bit of inflation, then you need a little more, because it peps up the economy. People get used to it, and it loses its effectiveness. Like an antibiotic, you need a new one; you need a new one. Well, I certainly thought that inflation was a dragon that was eating at our innards, so the need was to slay that dragon.”

The policy of the time was Keynesian – inject more money into the system in order to get the economy moving again. This was also the case in the UK in the early 1970’s but Jim Callaghan’s (Labour PM in the UK ousted by Thatcher in 1979) speech in 1976 had reluctantly recognised that this policy had run its course and a monetarist doctrine was about to become prevalent. Below is an extract from the speech.

“We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment. That is the history of the last twenty years”

With this paranoia about inflation central bankers began to implement a monetary policy targeting inflation in the medium term. In NZ the Reserve Bank Act 1989 established “price stability” as the main objective of the RBNZ. “Price stability” is defined in the PTA (Policy Target Agreement) as keeping inflation between 1 to 3% (originally 0-2%) – measured by the percentage change in CPI. Around the world central banks were adopting a more independent approach to policy implementation and with targeting inflation a new prevailing attitude seemed to be like an osmosis and suggesting that low prices = macro-economic stability as well. Also, raising interest rates is an unpopular political move and governments could now blame the central bank for this contractionary measure.

So are we now concerned that we will be entering another period of stagflation? Like the 1970’s we do have a supply-side issue (although not oil based) and expansionary demand side. The following are concerns:

Demand Side
– excessive fiscal stimulus for an economy that already appears to be recovering faster than expected.
– excessively accommodative with policies that combine monetary and credit easing
– monetisation of fiscal deficits will put pressure on inflation

Supply Side
– Rising protectionism
– Supply bottlenecks – container shortages and the Suez blockage
– Reshoring of FDI from low-cost China to higher-cost locations

However in saying this will the global supply side be positively influenced by better use of technological innovation in artificial intelligence and the return to normality on global supply distribution networks. Also will demand pressure eventuate especially when the threat of unemployment is ever present?

Major contributions to inflation in New Zealand – NCEA Level 2 External

Finishing off the Inflation external standard with my NCEA Level 2 class and came across an ASB Bank publication which outlines what the main drivers of inflationary pressure are in New Zealand. They list 5 categories which are shown below and note that housing and commodity prices are quite prevalent. This would suggest that the government are trying to get the RBNZ to target house prices.

Source: ASB Bank Economic Note

Outlook
It is forecast (ASB) that the CPI will rise to around 2.5% – cost-push and demand-pull factors with strong NZ$ being superseded by higher external costs and prices. The inflation target for the RBNZ is 1-3% with a target of 2% but the inflation figure above the midpoint should be treated the same as when inflation is below the midpoint. Therefore this does not mean that the RBNZ will necessarily raise interest rates.

Source: ASB Bank. Economic Note – 5th March 2021

UK growers see high wage inflation.

Since 2016 UK growers of fruit and vegetables have seen their labour costs rise by at least 34% since 2016. This is when farmgate prices have stayed virtually the same.
This increase threatens domestic production in the UK growers and they need a higher price to halt them locating overseas or finding another revenue stream with the land that they have.

Between 2015 and 2020 there has been an increase in the hourly rate for workers of 34% rising from £6.50/hour (NZ$12.40) to £8.72/hour (NZ$16.63). However many growers have seen a 40-50% rise in employment costs since 2015 as:

  1. Lower output and reduction in productivity with newly recruited UK labour because of Brexit. Fruit and vegetables are normally picked by some 70,000 to 80,000 migrant workers, mainly from eastern Europe who tend to be much more productive than local labour. From this year any foreign worker wanting to come to the UK will have to meet a minimum salary threshold of 25,600 – well above what farm pickers would normally be paid.
  2. A weaker £ also makes it less attractive for foreign workers as when they convert their income in £ it buys them less of their own currency.
UK Farmers Weekly

Labour costs account for 40-70% of a growers revenue which mean some are seriously looking at the financial viability of their business. This is concerning as the domestic growing industry contributes more than £3.8bn to the UK economy. What is true is that although some agricultural sectors are highly mechanised there is still a need for manual jobs carried out by labour. A report, by farm consultant Andersons suggested that a farmgate price increase of between 9% and 19% is needed simply to offset the increase in the National Living Wage (NLW) hourly rate – it will rise to £8.91/hour (NZ$17.12) from 1 April 2021. The problem with the NLW is that it doesn’t take into consideration the differences in the cost of living in a country e.g. London as compared to Manchester. However evidence suggests that workers are more motivated when the living wage is being paid and staff retention is higher.

Source: UK Farmers Weekly 15th February 2021

US velocity of money lowest since 1946

Velocity of circulation of money is part of the the Monetarist explanation of inflation operates through the Fisher equation:

M x V = P x T

M = Stock of money
V = Income Velocity of Circulation
P = Average Price level
T = Volume of Transactions or Output

For example if M=100 V=5 P=2 T=250.   Therefore MV=PT – 100×5 = 2×250. Both M x V and P x T are equivalent to TOTAL EXPENDITURE or NOMINAL INCOME in a given time period. To turn the equation into a theory, monetarists assume that V and T are constant, not being affected by changes in the money supply, so that a change in the money supply causes an equal percentage change in the price level.


Hoisington Investment Management -Q4 2020

However when the velocity of money in the US is falling, monetary policy which would otherwise cause inflation doesn’t seem to do so. The velocity of money fell 17.7% in 2020 with velocity for the year averaging an estimated 1.2, the lowest level since 1946 (see chart above). With less money going around the circular flow this frees up what available funds people have for financial investment which put up prices in asset markets especially in the housing market. However this money is with the higher income groups.

We have no idea of how the future is going to unfold because we have never seen anything like this before – to quote Rogoff and Reinhart – This time it is definitely different.

Source: Hoisington Investment Management – Q4 2020

How interest rates affect inflation – flow chart

Below is a useful flow chart for anyone studying monetary policy. Both the NCEA Level 3 and CIE A2 courses cover this topic.

Negative – lower interest rates might depress spending by some retirees who rely on interest income. But these counterproductive channels are small compared to the
Positive – lower interest rates = a lower propensity to save and a higher propensity to spend.

The side effects of monetary policy.
Falling interest rates = accelerating house prices = social problems and political anxiety.
If RBNZ kept interest rates at around 8% as in the 2000s to prevent the house price = New Zealand in deflationary spiral.

The economic and social consequences of deflation would be far worse than the (undeniable) problems with rising house prices. The low inflation / falling interest rate dynamic of the past two decades has been a global phenomenon, ultimately caused by a global change in the balance between savings and investment. The Reserve Bank of New Zealand could not have prevented this global trend from affecting New Zealand interest rates without causing severe damage to the economy. In New Zealand, the most important transmission channels are asset prices and the exchange rate. Falling interest rates tend to push asset prices up, which stimulates consumer spending. Falling interest rates also tend to reduce the exchange rate, which generates inflation via the prices of internationally-traded goods and services.

Source: Westpac Bank

A lack of containers adds to shipping costs and inflation.

Covid-19 has severely impacted the global trade for a number of reasons:

  • Container shortages as early as February 2020
  • Port congestion caused by increased checks at ports
  • Ship carriers cannot add more capacity as the entire global fleet is mobile.
  • Slow down in container emptying has led to a backlog of containers at many ports

Major Chinese ports like Qingdao, Lianyungang, Ningbo, and Shanghai are experiencing severe container shortages. This means that ships are leaving Chinese ports without a full load. Containers filled with consumer goods from Asia are usually unloaded, then filled with exports of other commodities. Products like meat, pulp and coffee, crops and lumber are then shipped in containers back to China. But, without the containers landing in these ports, there is nothing to fill for the home journey. As you’d expect, this is leaving exporters frustrated and very stressed, especially with seasonal crops needing to be shipped. See chart below for the increase in shipping costs from three major shipping companies – Maersk, Cosco and Triton.

SOURCE: Bloomberg

Baltic Dry Exchange – what is it?
The Baltic Dry Index (BDI), is issued daily by the London-based Baltic Exchange. It is reported around the world as a proxy for dry bulk shipping stocks as well as a general shipping market number cruncher. Every working day, a panel of international shipbrokers submits their assessment of the current freight cost on various routes to the Baltic Exchange. The routes are meant to be representative, i.e. large enough in volume to matter for the overall market. See chart below.

Inflation – an historical overview and how will covid-19 impact prices?

This is a very good video on inflation from The Economist – it discusses why over the past two decades inflation has remained low in good times and bad. There is a brief look at historical rates of inflation and policy with reference to Bill Phillips (Phillips Curve) and Paul Volker (US Fed Chairman) who increased the prime interest rate to 21.5% in 1981 to tackle inflation. Also low interest rates and government fiscal stimulus could start to see an upward movement in the inflation figure. Very useful for Unit 4 of the CIE AS and A2 Economics course.

Money velocity – you can’t have your cake and eat it

This post refers to Unit 4 of the CIE A2 Economics course. Velocity of circulation of money is part of the the Monetarist explanation of inflation operates through the Fisher equation:

M x V = P x T

M = Stock of money
V = Income Velocity of Circulation
P = Average Price level
T = Volume of Transactions or Output

For example if M=100 V=5 P=2 T=250.   Therefore MV=PT – 100×5 = 2×250
Both M x V and P x T are equivalent to TOTAL EXPENDITURE or NOMINAL INCOME in a given time period. To turn the equation into a theory, monetarists assume that V and T are constant, not being affected by changes in the money supply, so that a change
in the money supply causes an equal percentage change in the price level.

The speed at with which money goes around the circular flow is a significant indicator as to the economic activity of an economy. Money’s “velocity” is calculated by dividing a country’s quarterly GDP by its money stock that quarter – the bigger GDP is relative to the money supply, the higher the velocity.

Recessions – dampen the velocity by increasing the attractive of a store of value. People tend to save rather than spend. E.G. The Great Depression and the GFC. See graph for US velocity of money.

Covid-19 – with the closure of a lot of businesses and people worried about job security personal savings increased to 33.6% of disposable income. Also consumers didn’t have the money to spend.

The stimulus measures and the glut of dollars could cause problems once the consumer confidence starts to become prevalent. Inflation will inevitably rise again – which is not a bad thing considering the threat of deflation that we are currently experiencing. But the major concern is if the increase in spending spirals out of control with high inflation. It seems that central banks want the velocity of money to increase to kick-start the economy but they will need to consider how to control it if it gets above the ‘speed limit’. “You can’t have your cake and eat it”.

Source: Why money is changing hands much less frequently – The Economist 21-11-20