On the Money

Inflation’s suicidal spiral has begun

Peter Lawlor

I’ve been asked to give my thoughts about what we can expect for the rest of this year and beyond. If you are of a sensitive disposition, look away now. 

The next couple of years are going to see high and rising inflation which, in about a year from now, will turn into stagflation. Stagflation is the worst of all possible worlds; high and rising inflation coupled with falling output and rising unemployment.

Can’t anything be done? 

I have three immediate observations. First, that unfortunately it’s already too late and getting worse by the day. A calamitous misunderstanding of the role of expectations in the inflationary process has focused the attention of policymakers on the wrong object. While the authorities continue to search the stable, the horse is already many fields away.

Secondly, the models used by the authorities are at best woefully inadequate, at worst downright misleading. In a subsequent article, I’m going to look at the processes involved in constructing a model – God knows, we’ve all been the victims of inadequate modelling in the past couple of years.

Thirdly, when ineffectual policy measures, such as the occasional 0.25% increase in interest rates, are seen for the impotent tools they are, new policies will be adopted that will only make things worse. More on that in a moment.

I asked a psychologist friend of mine whether there is a name for the syndrome whereby a bad situation provokes behaviour that makes it worse. Unfortunately, he drew a blank. That’s a shame, it would be a useful shorthand term to describe the inevitable economic policy missteps that are going to characterise the remainder of 2022. Perhaps we should call it “Lemming Syndrome”. You see, the inflation cycle is one of those situations that tends to beget precisely the wrong policy responses. Specifically, Price Controls and Incomes Policies.

Policies which, instead of alleviating the situation, make it worse.

Price controls are not the panacea they seem to be. They breed massive discontent and lead to shortages, black markets and side deals

In the early stages of inflation, the big picture is invisible and we only notice the price increases that affect us directly. For example, if you’re running a clothes shop, you’ll be very aware of increases in the price of fabric, whereas someone working in web design, say, won’t be. Or, if you make amplifiers, you’ll pick up movement in the price of valves that won’t register for someone working in construction. And so on.

What the majority of people notice first, of course, is the price of food. The food writer Jack Monroe has been monitoring prices in her local supermarket over the last year and found the following: pasta has risen by 141%, rice by 344%, baked beans by 45%. It’s interesting to compare these vertiginous price rises with the ONS’s rather absurd estimate of an inflation rate of 5.4%.

With such shocking price increases, it’s pretty easy to see why, during every inflationary episode, the hideous blame genie escapes from its bottle. As I say, in the early stages we don’t see the big picture, we only see the prices that affect us. 

It looks like retailers and corporations are being greedy. This always happens during inflation. 

Last month, in the States, Senator Elizabeth Warren put it like this: “Giant grocery store chains force high food prices onto American families while rewarding executives and investors with lavish bonuses and stock buybacks. I’m demanding they answer for putting corporate profits over consumers and workers during the pandemic.” Remove the reference to the pandemic and that could be a quote from a politician in the Weimar Republic.

When inflation is conflated with corporate greed, price controls become the obvious solution. At the end of December, there was an article published in the Guardian that fell into all the ancient traps in its advocacy of price controls. Price controls are not the panacea they seem to be, quite the opposite: they accentuate inflation’s economic damage. Price controls breed massive discontent and lead to shortages, black markets, preferential treatment and side deals.

There’s an old joke from the Soviet era, a time of rigid price controls: 

A man went into a butcher’s in East Berlin.

“Do you have any meat?”

The butcher replied: “No, we don’t.”

So the man asked: “What about milk?”

To which the butcher responded: 

“Sir, we only deal with meat here. If it’s milk you want

then go across the street to the store where they don’t have any milk.”

Soon, the greed blame genie will be joined by its equally evil twin: the one that makes it look like inflation is the result of excessive wage demands. In reality, wage demands and union activity are caused by inflation, not the cause of it. However, this line of thinking inevitably leads to incomes policies. Yet again, these are doomed to disastrous failure. They cause social unrest, strikes, and deal a body blow to the economy.

However, be ready for prices and incomes policies. They are coming. 

Peter Lawlor is a trustee of the John Hicks Foundation in Oxford. He was formerly the Principal Economic Advisor to the German Stock Exchange (Deutsche Börse), and continues to act as an adviser to senior Wall St figures and political leaders. These are his own views and should not be imputed to any organisations with which he is, or has been, affiliated