Over the last 6 months, we have heard countless comments about the delicate situation faced by Central Banks, forced to make a rather impossible choice: either to take on inflation, or try bypass recession. This is indeed an impossible choice since a continued increase in interest rates meant to hold back inflation would eventually lead to economic slowdown. On the other hand, a slow increase in interest rates to safeguard economic growth would not suffice to offset inflationary pressure. Supporters of the second approach also argue that inflation is supply, not consumption driven.
The golden question thus becomes: isn’t precisely this indecision that risks causing stagflation? In other words, a situation where neither inflation is controlled, nor the economy grows. However, the good news is that large banks start to remember their ultimate goal: ensuring price stability.
Fed, the US Central Bank, is the first to announce a timetable for aggressive increase in interest rates, despite the economic slowdown. Even if the Q1 negative growth of -0.4% has just been published, I have no doubt that it came as no surprise to the Fed. Such figures do not come up overnight, but they rely on interim calculations. Thus, the statements about the increase in interest were very much informed.
Why does Fed overlook this slow down? Because this Central Bank sees the bigger picture, which shows that the negative dynamics has been induced by stock variations and import increases (with a negative impact on GDP calculation), while consumption has remained strong. Still, my hope is that it’s more than this.
I do hope that the Fed trail-blazes the return to normal. But what does “normal” mean now? Detoxing from the “drug” of printing money for the sake of offsetting economic cycles.
Before the 2008 economic crisis, the succession of periods of economic growth and recession used to be the normal. In economically good times, Central Banks used to dose growth by higher interest rates and, potentially, by increasing the minimum reserve requirements. During recession, interest rates used to be kept low, and liquidity on the money market was increased by bringing down the minimum reserve requirements. In parallel, governments were seeing higher budget deficits, fostering aggregate demand by public projects. But they also used to finance deficit exclusively through financial investors.
Unfortunately, an exceptional measure such as quantitative easing, which essentially meant creating large amounts of money in the aftermath of the 2008 crisis, ended up being misused. As, despite the economic theories, such a measure did not cause inflation in the decade after the crisis, central banks were increasingly tempted to use the new “button” without any restraint. Thus, they have willingly (or maybe not?) surrendered their independence to become funders of their own states and supporters of the respective government policies.
The newly-discovered magic “drug” seemed to give supernatural powers, including that of avoiding recession. It could even make economic cycles vanish. Growing at full or lower speed was the only way and the only reality investors would accept. Consequently, Central Banks not only lost their independence to the politics, but they also became prisoners of stock exchanges the collapse of which was out of the question.
Unfortunately, for more than a decade, Central Banks were too weak to free themselves of this game and close down printing press. The fact that they were lacking the necessary tools to accurately determine the right money printing didn’t matter too much. Seemingly, they simply forgot the very first chapter of the economy books which always start with the disclaimer that macroeconomics is not an exact science.
And with the pandemics, the magic “drug” came back stronger into the spotlight. The bigger the pain, the higher the dose, isn’t it? So, seeing quantitative easing going way beyond what the banks had “dared” to do before the crisis came as no surprise to anyone. And a sharp “V” recovery of economies followed. In fact, it was overdone because, as I was saying, Central Banks hadn’t had at any time a tool to accurately measure the consequences of their uncharted measures.
But a time came for them to admit that, indeed, printing money senseless will eventually cause inflation. One should not forget also that the inflationary pressure were present months before the Russian invasion, which is now seen as the root-cause of the inflationary flare. Excessive consumption stimulation prevented the supply growth from keeping up with the demand. And this snow-balled price rises across the board, from energy and raw materials to international transport, all fueled by a boosting demand.
Under such circumstances, saying that inflation is not consumption-driven, but only supply-driven, is rather questionable. The original evil had been caused by the poor calibration of the Central Banks’ interventions, and by them abusing money creation.
For this reason, to my mind, admitting that the top priority should be bringing inflation under control bodes well, even if it can lead to temporary recession. At the end of the day, it is the times of recession that force the business environment to take a deeper look into their efficiency and business models, and come up with innovative solutions that can help relaunch the business on healthier foundations. No wonder that finding motivation to do so in this age of free money that guarantees never-ending growth proved to be a difficult exercise.
Prioritizing inflation over economic growth is expected to blossom also in Europe, where the over-relaxed mood of the European Central Bank’s governor has been now replaced by a fast-forwarded phasing out of the government security purchase programmes, which means quantitative easing. However, unlike the US, the EU is at the mercy of the hydrocarbon market, which it imports extensively. In this background, any interruption for whatever reason of the imports of hydrocarbons could act as a very effective brake which the ECB would definitely not want to overlap with any rushed increase in interest rates.
What about Romania? For the time being, we are yet to set our priorities straight while navigating between inflation and economic growth, not to mention the rate of exchange. Therefore, inflation continues to outgrow the expectations, which were high anyway. That the increase in interest rates remains too shy, we can see from lending dynamics that outtakes the dynamics of the bank deposits. This is the very opposite of a situation that would allow easing inflation. In fact, the latest figures about the developments in retail show a 5.6% year on year increasing, slightly above the EU average.
In this context, I believe that we must be aware that high inflation has a much stronger effect on the wealth of the population than a temporary economic stagnation or even a slight recession. And this because inflation eats up not only the purchasing power of the current wages, but also the real value of the savings made by the population over the years. For this reason, the population has the most to lose from high inflation, while the state budget gains from inflated revenues, from getting financing at negative real interest rates and from the devaluation of the public debt balance. Conversely, in times of recession and low inflation, the state budget is the main loser and the population is only half a loser, particularly due to higher unemployment. Paradoxically, the wages of those who preserved their jobs continued to grow even throughout recessions in Romania.
We should also ask ourselves whether, on a tense labor market where the demand overtakes the supply, maybe economic growth should be thus calibrated in such a way to avoid triggering a wage-inflation spiral. High economic growth rates coupled with a declining workforce can only lead to inflation as long as demographics remain negative, the education system is unable to produce more skilled workers, and investments do not suffice to mitigate dependence on the human factor.
And one closing remark. Lately, there have been talks about the unavoidability of an upcoming economic crisis. But economic stagnation or recession does not amount to crisis. After all, this fear is just another outcome of the “unreal” world built by the quantitative easing, and of taking the growth of economies for granted. In fact, recession is, too, part of the economic volatility the human society evolved through during a time where we used to be less complacent, and money came with a price.
Have a great weekend!
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