That’s the title of my new column in Independent Australia. I plan to write fortnightly from now on.
Now that quantitative easing is no longer needed, the problem is how to manage the huge increase in money balances that is driving demand. This is not a new problem; it arises every time a lot of spending is needed to handle an emergency, and we know what works and what does not. In the aftermath of World War I, governments in the UK and Australia sought to unwind the inflation created by wartime spending and return to the gold standard. The result was a long period of economic weakness, culminating in the Great Depression. By contrast, after World War II, wages and prices were allowed to rise, as wartime rationing ended and reconstruction gradually removed constraints on production.
As long as the real value of wages is maintained, a once-off increase in the price level is a small price to pay for avoiding economic disaster during the pandemic. The reconstruction of supply chains, along with the underlying increases in productivity generated by technological progress, will allow a gradual return to lower rates of inflation. We can also hope for some additional gains arising from the experience of the pandemic with remote work, telecommunications and home delivery of goods and services.
Once the current upsurge in prices is past, we need to reconsider whether the inflation targeting regime introduced around the world in the 1990s, based on frequent small adjustments to the central bank interest rates, is still appropriate. Inflation targeting, failed to prevent the Global Financial Crisis, and was abandoned during the pandemic. Even though interest rates are rising in the short run, there’s still very little capacity to cut them in the event of a new emergency. It might well be better to target growth in the money value of GDP, and to accept inflation somewhat higher than the 2-3 per cent range that has been aimed for, though not always reached, under inflation targeting.
But this is a question for another day. The inflation we have observed in the last year was not caused by low-wage workers, most of whom did not see much benefit from the big expenditure during the pandemic. They should not be asked to bear the costs of a misconceived program of deflation.