Double-digit price inflation is here. Anyone who paid attention to fiscal and monetary policy knew this would happen sooner or later. The recent Federal Reserve report Increase of 0.75 basis points of the federal funds interest rate will not be enough to stem an inflationary avalanche that reckless politicians without any knowledge of the history and experiences of other countries have been unleashing for years.
For part of the 20th century, John Maynard Keynes and Milton Friedman constituted opposing paradigms of economic policy. For Keynes government spending was crucial to stimulate demand for goods and services during a downturn; monetary policy as a stimulus had limits. Friedmanmeanwhile, was critical of government spending, but was supportive of monetary policy: in times of recession, monetary stimulus was needed to prevent the crisis from turning into a depression.
The irony of the past 14 years, that is to say since the financial crisis of 2008, is that governments everywhere have resorted simultaneously to Keynesian and Friedmanian policies: massive public spending and “printing” of money to avoid depression.
The unprecedented degree of these interventions was bound to cause serious damage. All it would take was for people to feel more confident about applying for and granting credit and spending money. All this stimulus would then generate excess demand vis-à-vis a supply of goods and services that would not be able to keep up. If on top of that, some factors were to further limit the ability to produce enough goods to satisfy demand (a pandemic, a war), the effect would be all the more acute.
Welcome to the new reality. A simple look at US debt tells the story. Total government and household debt is over $90 trillion, more than four times what the economy produces each year. The past two years have seen a $6 trillion Budget deficit related to COVID-19 which brought federal spending to the equivalent of 30.5% of GDP, more than 5 percentage points above 2008, the year the financial crisis triggered a wave of massive government bailouts. And that does not take into account the fiscal stimulus. Between 2008 and 2020, the money supply almost doubled, and in the last two years alone, it has increased by 46 percent!
Where’s the inflation, many “experts” mockingly asked in the years following the financial crisis, when fiscal and monetary stimulus (Keynes and Friedman) failed to produce the price rises that fools predicted like us ? In the absence of credit and strong consumer spending, new money inflated the price of various assets. In 2021, home equity in the United States was enormous $14.2 trillion according to one study, even though wages had increased very little. Eventually, inflation would affect producer and consumer prices. And here we are, with the Fed desperately raising the fed funds rate to try to stem the inflation that is now the biggest economic concern in the world.
We haven’t seen anything yet. In other parts of the developed world, a sovereign debt crisis is brewing again, like in 2012. Interest rate on public debt in highly indebted countries such as Spain and Italy quickly tripled, as the European Central Bank signaled that it, too, was ready to stem inflation by raising rates. But now the central bank faces a dilemma: does it keep raising rates and send Spain, Italy and others into default territory, or slow down and risk- fueling inflation even more? For now, it is trying to square the circle by saying that it will continue to raise rates and at the same time buy more sovereign debt from highly indebted countries. Soon the bank will realize the grotesque contradiction and pay the consequences. How long before the more financially sound northern Europeans, finding themselves subsidizing southerners, start to question the euro again?
This is not the place to discuss the social and political consequences that will flow from the new inflationary era – and its corollary, a major recession, which is already in the air. (According to one estimate, retail spending fell by 15 percent on an annual basis.) But these consequences will be enormous. The hens have finally returned to roost.
Álvaro Vargas Llosa is a senior researcher at the Independent Institute in Oakland, California. His latest book is “Crossing the world: immigration, civilization and America”.