Prices priority
Inflation is more than rearing its ugly head. It is lashing out with its fangs at the ready, threatening to poison the economic situation more than it is already. That applies internationally, where several major countries are close to recession but...
Inflation is more than rearing its ugly head. It is lashing out with its fangs at the ready, threatening to poison the economic situation more than it is already. That applies internationally, where several major countries are close to recession but are experiencing inflation at the same time. It certainly applies to Malta as well, where the latest reading of the harmonised index for July confirms that we are among the worst hit by this economic malady.
The twin problems of inflation and slowing growth or recession are bringing about one of the most feared economic situations - stagflation. Inflation prevails even as economies stagnate, or worse. This leads to the danger of policy contradictions, which this column touched upon a few weeks ago when the European Central Bank (ECB) acted to push up interest rates, notwithstanding clear signs that the main drivers of the EU economy were gasping for breath.
I was among those who criticised that decision. At a time of economic weakening, I argued, one should try to stimulate economic activity, rather than slow it down further with higher interest rates. My view did not have majority support then, though more are coming round to it now. It is not in line with that of central bankers, certainly not those of the ECB and the Bank of England.
One has to appreciate their position, which rests on two legs. First of all most central banks are tasked, primarily, to keep inflation in check. In some cases the job of the governor of a central bank depends on the bank's ability to maintain inflation within a given target range. New Zealand was among the pioneers of that approach. Nowadays both the ECB and the Bank of England operate within clearly set parameters.
The second reason is more technical. A strong school of economists believes that managing or at least influencing expectations has a large role to play in any attempt at economic management. The approach takes into account behaviour. If prices are rising, trade unions traditionally behave by putting claims for compensation for inflation. If compensation is given, rising prices will have a ratchet effect.
A vicious circle will develop. That is why the ECB and the Bank of England have been responding to inflationary pressures within a weakening economy by deliberately raising interest rates. They want to nudge employers into resisting claims for compensatory higher wages by making money dearer for them.
Practically all employers require overdrafts and loans; overdrafts for day-to-day running of their enterprises, loans to help finance new investment.
A theoretical discussion about who's right or wrong in the approach to inflation at times of weakening economic activity can go on forever. One can point out that probably the most important bank in the world, the Federal Reserve Bank of America, has been paying more attention to job creation or preservation, than to inflation, and in the period since the US economy started faltering once the housing boom bubble burst, has tended to cut interest rates, in contrast to the ECB.
At the end of it all - or maybe at the start - what one is talking about is value judgment. If a central bank puts inflation first though the economy is weakening or expected to do, it is essentially telling employees and employers to bear the burden, to suffer a cut in real wages on the one hand, and in real profits on the other as consumer demand weakens under the ripple effect of uncompensated price increases.
The current situation is further complicated, well beyond the stance and theoretical preference of central banks and economists at times of weak economic activity coupled with inflation. The current inflation hitting most of the world is not coming about through higher demand - the old too much money chasing too few goods. It is, as everyone acknowledges, essentially due to the sharp uptrend in the price of crude oil and its multiple consequences, among other things on food prices, which have also been soaring.
Raising interest rates will not affect the price of crude oil. It will simply squeeze consumers and suppliers too. It will also discourage investment, though that is the key to economic growth. That is the price to pay to try to stave off still faster inflation, since, if inflation gets out of control, its consequences on employment would be worse than the squeeze brought about at the early stage by central banks raising interest rates.
There can be no arguing with that. One should not envy central bankers, particularly at this stage of looming recession and possibly worse, plus high crude and related prices. (The fact that the price of crude has now fallen sharply from its recent highs does not remove the fact that it is still very high and, therefore, continues to feed inflation.)
The situation in Malta is, if anything, worse than that of the average EU country. Our annual rate of inflation (measured month on year-ago month) is rising faster than the EU average. That was happening before the election, and predictably became part of the political debate. It is still happening now. Political use will continue to be made of Malta's faster inflation.
Allowing for that, it is essential for the authorities to delve more deeply into the matter, to try to identify why our rate of inflation is higher than what is inevitable because it is imported. It does not seem to be the case that average wages are being pushed up through irresponsible union pressure. What, then, is happening?
The authorities should start delivering believable answers, in addition to telling consumers that they should shop and choose wisely.
The twin problems of inflation and slowing growth or recession are bringing about one of the most feared economic situations - stagflation. Inflation prevails even as economies stagnate, or worse. This leads to the danger of policy contradictions, which this column touched upon a few weeks ago when the European Central Bank (ECB) acted to push up interest rates, notwithstanding clear signs that the main drivers of the EU economy were gasping for breath.
I was among those who criticised that decision. At a time of economic weakening, I argued, one should try to stimulate economic activity, rather than slow it down further with higher interest rates. My view did not have majority support then, though more are coming round to it now. It is not in line with that of central bankers, certainly not those of the ECB and the Bank of England.
One has to appreciate their position, which rests on two legs. First of all most central banks are tasked, primarily, to keep inflation in check. In some cases the job of the governor of a central bank depends on the bank's ability to maintain inflation within a given target range. New Zealand was among the pioneers of that approach. Nowadays both the ECB and the Bank of England operate within clearly set parameters.
The second reason is more technical. A strong school of economists believes that managing or at least influencing expectations has a large role to play in any attempt at economic management. The approach takes into account behaviour. If prices are rising, trade unions traditionally behave by putting claims for compensation for inflation. If compensation is given, rising prices will have a ratchet effect.
A vicious circle will develop. That is why the ECB and the Bank of England have been responding to inflationary pressures within a weakening economy by deliberately raising interest rates. They want to nudge employers into resisting claims for compensatory higher wages by making money dearer for them.
Practically all employers require overdrafts and loans; overdrafts for day-to-day running of their enterprises, loans to help finance new investment.
A theoretical discussion about who's right or wrong in the approach to inflation at times of weakening economic activity can go on forever. One can point out that probably the most important bank in the world, the Federal Reserve Bank of America, has been paying more attention to job creation or preservation, than to inflation, and in the period since the US economy started faltering once the housing boom bubble burst, has tended to cut interest rates, in contrast to the ECB.
At the end of it all - or maybe at the start - what one is talking about is value judgment. If a central bank puts inflation first though the economy is weakening or expected to do, it is essentially telling employees and employers to bear the burden, to suffer a cut in real wages on the one hand, and in real profits on the other as consumer demand weakens under the ripple effect of uncompensated price increases.
The current situation is further complicated, well beyond the stance and theoretical preference of central banks and economists at times of weak economic activity coupled with inflation. The current inflation hitting most of the world is not coming about through higher demand - the old too much money chasing too few goods. It is, as everyone acknowledges, essentially due to the sharp uptrend in the price of crude oil and its multiple consequences, among other things on food prices, which have also been soaring.
Raising interest rates will not affect the price of crude oil. It will simply squeeze consumers and suppliers too. It will also discourage investment, though that is the key to economic growth. That is the price to pay to try to stave off still faster inflation, since, if inflation gets out of control, its consequences on employment would be worse than the squeeze brought about at the early stage by central banks raising interest rates.
There can be no arguing with that. One should not envy central bankers, particularly at this stage of looming recession and possibly worse, plus high crude and related prices. (The fact that the price of crude has now fallen sharply from its recent highs does not remove the fact that it is still very high and, therefore, continues to feed inflation.)
The situation in Malta is, if anything, worse than that of the average EU country. Our annual rate of inflation (measured month on year-ago month) is rising faster than the EU average. That was happening before the election, and predictably became part of the political debate. It is still happening now. Political use will continue to be made of Malta's faster inflation.
Allowing for that, it is essential for the authorities to delve more deeply into the matter, to try to identify why our rate of inflation is higher than what is inevitable because it is imported. It does not seem to be the case that average wages are being pushed up through irresponsible union pressure. What, then, is happening?
The authorities should start delivering believable answers, in addition to telling consumers that they should shop and choose wisely.