Price stabilisation and extent of tight monetary policy

‘Today American policymakers face a stark choice. Either, they can fight inflation by continuing to hike interest rates to generate unemployment and bring down aggregate demand. Or, they can employ a surgical approach that reins in the price increases that have been driving inflation, while encouraging investments to overcome chronic supply chain issues.’ – Excerpts from a recent Guardian published article ‘Inflation is causing real pain. But raising interest rates will make it worse’ by Isabella Weber, and Mark Paul

For years, Neoliberalism has been practiced in many countries and continues to remain heavily dominant in multilateral policy frameworks of institutions such as the International Monetary Fund (IMF), and the World Trade Organization (WTO).

Under the neoliberal assault capacity of governments to deliver diminished over time, while the role of outsourcing increased, and together with unfettered markets and less regulated supply-chains, in turn, allowed greater space to mostly unaccountable private sector.

This resulted in weak governments on one hand, and allowed, on the other hand, private sector to make sub-optimal decisions in terms of benefit to people and environment, since highest priority was given to the ‘profit signal’ in determining what to, how to, how much to, and at what pace to produce, etc.

Hence, when the Covid pandemic hit, the world could not respond in a satisfactory manner neither in terms of effectively dealing with the health/vaccine aspects, nor did supply chains proved resilient enough to provide a rather quick balance to supply-demand gap globally, or to safeguard appropriately enough against speculative, purely profit-motivated actions by producers, and the middle-men overall.

In a recent Project Syndicate (PS) published article ‘Curbing commodity-market speculation’, renowned economist Jayati Ghosh indicated that sharp movements in the prices of crude oil and wheat, for instance, pointed towards strong speculative undercurrents, which needed to be checked actively. She indicated in this regard: ‘Primary commodity prices have been on a roller-coaster ride for the past year, and especially for the past six months.

In the futures markets, crude oil prices rose by 39% in the month from February 8 to March 8, 2022, from $89 per barrel to $124 per barrel, and then fell by 23% in the following month to $95 per barrel. The price climbed again, to $122 per barrel, on June 8, but had declined to $88 per barrel on August 4 – below the level of early February.

Global prices of wheat futures have exhibited similar volatility. The price of soft red winter wheat soared from $332 per metric ton in January to $672 per ton in April, but by June had fallen to $380 – still about 50% higher than a year ago, but well below this spring’s crazy peaks.’

Decoupling needs to take place in terms of the extent to which inflation is primarily a supply-demand generated phenomenon, including the role of war in Ukraine accentuating such gaps, and where this is because of highly profit-minded, speculative activity.

In this regard, Jayati Ghosh in the same article indicated: ‘These dramatic price movements were not triggered by changes in real output and demand. Blaming big commodity-price spikes on supply shortages caused by Russia’s war in Ukraine does not capture the full truth.

In particular, the large increases in Big Oil and agribusiness firms’ profit margins indicate that they raised prices of energy and food, respectively, well beyond any level that could be justified by their own cost increases. But frantic speculative activity, mainly by financial companies like hedge funds that dominate trading, has made matters much worse…’ Such thinking is broadly missing globally, including in developing countries like Pakistan, and the role of monetary policy needs to be seen accordingly, unlike the situation where there is over-reliance on monetary tightening and lesser on supply-side/regulatory measures.

The other problem that this Neoliberalism brought, given its over-reliance on neo-classical/monetarist philosophical inclination, was that inflation was mostly seen and tackled as primarily a monetary phenomenon.

The same recipe flowed through educational programmes of elite universities globally – broadly aped by universities at home, trying to create, it strongly appeared, a compatibility image with big name global universities than having serious indigenous reflection like that which took place in China over the last many decades, and inform policymakers accordingly – where a number of policymakers who later served in their respective countries practiced this with virtually monotone preference, and also with the backing of countries under IMF programmes.

Pakistan, over the last four decades, has suffered on both these counts, which brought at most short-term macroeconomic stabilization, including reining in high inflation, and at a high level of growth sacrifice through deep aggregate demand depression that this required.

This was because developing countries in general have rather shallow financialization, and a significant determinant of inflation remained fiscal/supply determined where policy focus remained weak and where institutional deficiencies caused inflation to resurface. Moreover, lack of export enhancement and import-substitution also did not allow the country to reduce the impact of imported inflation, especially when shock-induced commodity prices spiked.

In the wake of pandemic-caused supply chain commodity crisis, this two-dimensional determination, that is inflation being caused both as a result of aggregate demand and supply side influences – including lack of regulatory frameworks in place allowing significant speculative activity to continue globally – has become a reality for both developing and developed countries there is a need to not rely heavily on the routine mantra of tackling inflation primarily through raising interest rates.

On the contrary, path dependent neoliberal nature of policymakers overall has meant that this reality has continued to be mostly ignored for a number of months now. In the meantime, at the back of high inflation, interest rates have been raised in big volumes and at high frequency in both developed and developing countries.

On one hand, this has led to sharply activating the cost-push inflationary channel, which has significantly diminished the inflation-reducing impact of aggregate demand suppression. Hence, inflation overall has continued to rise in many developing and developed countries over many months, reaching decades-high levels in many countries.

On the other hand, higher interest rates led to serious capital flight from developing countries, which both increased the component of imported inflation under weaker domestic currencies against the US dollar, and higher debt repayment requirements increased already difficult debt situation of many developing countries. Already a few countries like Zambia and Sri Lanka have defaulted on their debt repayment; and on the other hand, the US is already in a technical recession.

It is in this context that the point being made Isabella Weber and Mark Paul in the article cited above needs to be taken very seriously and rather quickly by policymakers, and in programme conditionalities brought forward, for example, by the IMF. Hence, there needs to be a more cautious monetary tightening approach virtually everywhere, and it would make sense to lower interest rates where revisiting of this policy provides room.

In tandem, non-neoliberal, meaningful regulatory frameworks need to be put in place to check supply-side bottlenecks, including speculative activity. It would also make sense for countries to learn from the new non-neoliberal draft constitution of Chile, as a learning source to dismantle neoliberal frameworks.

Major treasuries need to both adopt a more cautious approach while raising interest rates to tackle inflation, given a significant supply-side nature of inflation and together with IMF need to take the following two steps to mitigate the impact of imported inflation and higher interest rates (in developed countries) on developing countries.

Firstly, work towards quick release of fresh allocation of special drawing rights (SDRs). In this regard, US treasury should give an immediate nod to the IMF for release of SDRs to the maximum amount of $650 billion, for which no Congressional allowance is required.

In a related aspect, the IMF should also announce immediate cessation of its notorious policy of charging ‘surcharges’ on late repayments by countries. Secondly, a meaningful debt restructuring process should be started immediately at the global level, where private sector is actively and effectively involved in the debt restructuring process – since it has formed a significant portion of many debtor countries’ portfolio — in addition to restructuring process of bilateral/multilateral debt.

Here, it needs to be pointed out that adopting a well-balanced inflation reduction policy in terms of monetary and fiscal/regulatory/supply-side measures will also likely incentivize otherwise much-needed investments into renewable energy sector, which is indeed exceedingly important, given a fast-unfolding climate change crisis.

Moreover, reportedly a recently passed bill ‘Inflation Reduction Act’ (IRA) by the US Congress, and signed into law by US President Joe Biden, will also likely help in both reducing inflation, and in more effectively dealing with climate change crisis, health care, and taxation, among other possible issues facing US economy.

Economics Nobel laureate, Joseph Stiglitz, in his recent PS published article ‘Why the Inflation Reduction Act is a big deal’ pointed out in this regard: ‘US Senate Democrats’ compromise bill, the Inflation Reduction Act (IRA) of 2022, addresses not just inflation but also several key longstanding problems facing our economy and society. …For those worried about excessive demand, there is more than $300 billion in deficit reduction. And on the supply side, the bill would mobilize $369 billion of investments in energy security and decarbonization.’

It makes sense, therefore, that other countries should also look to draw possible lessons from IRA for the benefit of policy at home. The nature of crises at hand is more global than ever, it strongly appears, and so should the effort be to learn and act in a more global way both in terms of learning from mistakes of a predominantly neoliberal past, and forging a more social democratic future. This is also important for undoing the undesirable political instability consequences like rising polarization/radicalization, and politics of ‘fear of others’ in both domestic and global contexts.

There is another very important aspect that needs to be kept in mind while overly relying on adopting a tight monetary stance, which is with regard to rather long-term nature of monetary policy transmission process.

Hence, in general, it takes time lag of around 12 to 18 months for seeing the full impact of monetary policy instrument usage on the real economy; in this case for the impact of raising interest rate on aggregate demand, and output.

This could, very well, cause deep deflationary consequences, given inflation is significantly a supply-side phenomenon as well, and prices of crude oil, food, and other commodities may have come down a lot earlier. This is because the underlying ‘supply shock’ may dissipate for instance due to an earlier resolution of war in Ukraine, or as a consequence of possible strong regulatory steps putting a rather quick damper on speculative activity.

Cautious monetary tightening stance, is therefore, not only important for avoiding recessionary consequences in the short-term, but is also crucial for avoiding ushering-in of strong deflationary consequences in the medium to long-term, which may also end up taking many parts of the global economy into a depression.

Copyright Business Recorder, 2022