It was a mistake to accept a ‘reference price’-determination process for basic commodities led by finance
There are strong interrelations between economic policy, culture, and power relations in society. This is quite evident in the restrictive monetary policies undertaken by central banks the world over when confronted with the recent inflationary outbursts.
Restrictive monetary policies are a standard answer to inflation. But they are not costless, exerting a downward pressure on output and employment. Thus, two questions arise: are they the correct answer in general? And are they, in this specific situation?
My answer is different from the mainstream one. The theoretical background pointing to restrictive monetary policies as the general answer to inflation does not have general validity, though it may hold in some specific circumstances. And, when confronted with the present inflationary episode, there are other policies we should consider first.
An old-fashioned quantitative theory of money is still often referred to (or implicitly relied on) by the media, and occasionally by professional economists, in support of the argument that price increases are caused by increases in the amount of money in circulation. But, as Kaldor once pointed out to Friedman, the causal link may go in the opposite direction: when prices increase, banks may be led to increase the money amount of their loans, thus increasing the supply of bank money. Moreover, when confronted with increasing aggregate demand, aggregate output too may increase, unless we are in a situation of full utilization of productive capacity, which is very rare – and certainly not our present condition.
But for sure there is an avenue through which restrictive monetary or fiscal policies exert downward pressure on inflation, and it is through the impact of a reduction in employment on the bargaining power of workers, hence on wage dynamics. Thus, these policies are an instrument of redistributive policies, not a class-neutral policy choice. (In this respect we can also notice that they favor the profits of banks, insurance companies, and financial institutions in general).
In sum, restrictive monetary policies should be considered with caution when confronted with output inflation. They are instead, quite often, a useful tool for countering asset inflation.
In the present situation, we are confronted with a multi-faceted inflationary outburst. The Covid pandemic first, then the war in Ukraine, ignited inflation by disrupting global supply chains, then gas and agricultural markets. Now the difficulties of navigation through the Gulf of Aden and the Red Sea increase transport costs and further disrupt supply chains.
Simplifying a complex matter, we can say that the restructuring of supply chains is certainly not favored by restrictive monetary policies. And, as far as gas and agricultural markets are concerned, there has been a clear overreaction of prices to the underlying admittedly difficult situation (with oil markets also displaying excess variability). Such an overreaction – the main element in the inflationary outburst – is mainly due to the financial markets that play a basic role in the price-determination process for these commodities. Financial markets do not behave in accordance with the efficient financial markets theory, driving prices in such a way as to reflect the underlying real situation: they are bent to overreact, driven by speculation.
It was a mistake – an enormous mistake – to accept a ‘reference price’-determination process for basic commodities led by finance, while direct (and often long-term) bargaining between companies at much lower prices inflates the companies’ profits, with selling prices for final products linked (by informal collusion if not by formal rules, as is the case for electricity) to the reference price. Countering this situation requires active anti-trust policies, a revision of some regulations, and more generally an active policy aiming at a retrenchment of finance (and the financialization of commodities in particular), whose growth as a percentage of GDP over the past few decades is the main cause of the growing instability of the world economy.
Such policies imply a wide redistribution of power in the economy and in society at large. They have no possibility of being implemented if not supported by a widespread recognition of the failures of neoliberal theories and policies, and this in turn requires turning upside down some established pillars of mainstream economic culture. We should recognize that culture and politics, in their more general meaning, have a deep influence on the formation of economic policy strategies.
Alessandro Roncaglia is Emeritus Professor of Economics at Sapienza University in Rome and a member of the Accademia Nazionale dei Lincei. He is the author of many books and articles. His Power and Inequality: A Reformist Perspective is just appearing in the INET “Studies in New Economic Thinking” book series with Cambridge University Press.
