Inflation phobia hastens recessions, debt crises

Anis Chowdhury and Jomo Kwame Sundaram

SYDNEY and KUALA LUMPUR, Sep 27, 2022 (IPS) - Inflation phobia among central banks (CBs) is dragging economies into recession and debt crises. Their dogmatic beliefs prevent them from doing right. Instead, they take their cues from Washington: the US Fed, Treasury and Bretton Woods institutions (BWIs).

Costly recessions 

Both BWIs – the International Monetary Fund (IMF) and World Bank – have recently raised the alarm about the likely dire consequences of the ensuing contractionary ‘race to the bottom’. But their dogmas stop them from being pragmatic. Hence, their policy analyses and advice come across as incoherent, even contradictory. 

Ominously, the Bank has warned, “[t]he global economy is now in its steepest slowdown following a post-recession recovery since 1970”. As “central banks across the world simultaneously hike interest rates in response to inflation, the world may be edging toward a global recession in 2023”. 

Warning “Increased interest rates will bite”, the IMF Managing Director has urged countries to “buckle up”, acknowledging anti-inflationary measures threaten recovery. “For hundreds of millions of people it will feel like a recession, even if the world economy avoids” two consecutive quarters of contracting output. 

She also noted US Fed rate hikes have strengthened the dollar, raising import costs and making it costlier to service dollar-denominated debt. But reciting the mantra, she claims if inflation “gets under control, then we can see a foundation for growth and recovery”. 

This contradicts all evidence that low inflation comes at the expense of robust growth. Per capita output growth and productivity growth both fell during three decades of low inflation. Also, low inflation has not prevented financial crises. 

Even if growth recovers, recessions’ scars remain. For example, an IMF study found, “the Great Recession of 2007–09 has left gaping wounds”. Over 200 million people are unemployed worldwide, over 30 million more than in 2007. 

A 2018 San Francisco Fed study assessed the Great Recession cost Americans about $70,000 each. The Harvard Business Review estimated, over 2008-10, it cost the US government “well over $2 trillion, more than twice the cost of the 17-year-long war in Afghanistan”. 

Counting the costs

“The human and social costs are more far-reaching than the immediate temporary loss of income.” Such effects are typically much greater for the most vulnerable, e.g., the youth and long-term unemployed. 

Studies have documented its harmful impacts on wellbeing, particularly mental health. Recessions in Europe and North America caused over 10,000 more suicides, greater drug abuse and other self-harming behaviour. Adverse socio-economic and health impacts are worse in developing countries with poor social protection. 

Interest rate hikes during 1979-82 triggered debt crises in over 40 developing countries. The 1982 world recession “coincided with the second-lowest growth rate in developing economies over the past five decades, second only to 2020”. A “decade of lost growth in many developing economies” followed. 

But Bank research shows interest rate hikes “may not be sufficient to bring global inflation back down”. The Bank even warns major CBs’ anti-inflationary measures may trigger “a string of financial crises in emerging market and developing economies”, which “would do them lasting harm”. 

Developing country governments’ external debt – increasingly commercial, costing more and repayable sooner – has ballooned since the 2008-09 global financial crisis. The pandemic has caused more debt to become unsustainable as rich countries oppose meaningful relief. 

No policy consensus

The Bank correctly notes, “A slowdown … typically calls for countercyclical policy to support activity”. It acknowledges, “the threat of inflation and limited fiscal space are spurring policymakers in many countries to withdraw policy support even as the global economy slows sharply”.

It also suggests, “policymakers could shift their focus from reducing consumption to boosting production…to generate additional investment and improve productivity and capital allocation…critical for growth and poverty reduction.”

However, it does not offer much policy guidance besides the usual irrelevant platitudes, e.g., CBs “must communicate policy decisions clearly while safeguarding their independence”. 

It even blames “labor-market constraints”. For decades, the Bank promoted measures to promote labour market flexibility, ostensibly to increase participation rates, reduce prices, via wages, and re-employ displaced workers. 

Such policies since the 1980s have accelerated declining productivity growth and real incomes for most. They have reduced labour’s share of national income, increasing inequality. To make matters worse, the Bank misleadingly attributes many policy-induced economic woes to high inflation. 

In May, the IMF Deputy Managing Director argued wages did not have to be suppressed to avoid inflation. She called for CB vigilance and “forceful” actions against inflation, which “will remain significantly above central bank targets for a while”.

No more Washington Consensus

In June, a Fund policy note advised allowing “a full pass-through of higher international fuel prices to domestic users”. It advised recognizing the supply shock causes of contemporary inflation and protecting the most vulnerable. 

But more alarmist Fund staff urge otherwise. In July, its ‘chief economist’ urged, “bringing [inflation] back to central bank targets should be the top priority … Central banks that have started tightening should stay the course until inflation is tamed”. 

Although he acknowledged, “[t]ighter monetary policy will inevitably have real economic costs”, without any evidence, he insisted, “delaying it will only exacerbate the hardship”.

In August, the Bank of International Settlements (BIS) head urged shifting attention from managing demand to enabling supply. He warned central bankers had for too long assumed that supply adjusts automatically and smoothly to shifts in demand. 

He warned, “Continuing to rely primarily on aggregate demand tools [i.e., the interest rate] to boost growth in this environment could increase the danger, as higher and harder-to-control inflation could result”.

But the BIS ‘chief economist’ soon urged major economies to “forge ahead with forceful” interest rate hikes despite growing threats of recession. He did not seem to care that the rate hike gamble to fight inflation may not work and its costs could be astronomical. 

Inflation fear mongering

Influential economists at the US Fed, Bank of England, Fund and BIS fear “second-round” effects of mainly supply-shock inflation due to “wage-price spirals”. 

But Fund research acknowledged, “little empirical research …[on]… the effects of oil price shocks on wages and factors affecting their strength”. It found very low likelihood of such ‘pass-through’ effects due to significant labour market changes, including drastic declines in unionization and collective bargaining. 

It reported “almost zero pass-through for 1980-1999” and negligible effects during 2000-19, before concluding, “In a broad stroke, the pass-through has declined over time in Europe”. Similar findings have been reported by others.

Reserve Bank of Australia (RBA) research found “the current episode has many differences to the 1970s, when a wage-price spiral did emerge”. It concluded, “There are a number of factors that work against a wage-price spiral emerging, … implying that the overall risk in most advanced economies is probably quite low”. 

Australian professor Ross Garnaut has suggested, “the spectre of a virulent wage-price spiral comes from our memories and not current conditions”. Sadly, despite all the evidence, including their own, the Fund and RBA still urge firm CB actions against inflation! 

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Comment on “Social Justice and Affirmative Action in Malaysia: The New Economic Policy after 50 Year

Kwame Sundaram Jomo,

Asian Economic Policy Review Volume 18, Issue 1, January 2023, pp 120-121

https://doi.org/10.1111/aepr.12411.

First published: 26 September 2022.

Any meaningful assessment of Malaysia's New Economic Policy (NEP) (Lee, 2022) should be historical. One question which arises here is how one does historical political economy. After all, there are many different schools of political economy, even if few have addressed “affirmative action.”

A key question is how one treats normative issues that inevitably come up. How one understands notions such as “social justice” has long been contested. These are often understood and invoked very differently. And how is a term such as “affirmative action”, which arose in response to US civil rights struggles in the middle of the 20th century, to be understood in other contexts?

When first announced to the Malaysian nation in mid-1971, the NEP was presented as being needed for building “national unity” following the divisive events of May 1969. The NEP has often been presented officially and by others as responding to “race riots” following the young nation's third general elections in which the incumbent multi-ethnic Alliance coalition lost its electoral majority. This perspective implies inter-ethnic economic disparities were responsible for “May 1969”.

Anand's (1982) Theil decomposition suggests that less than a tenth of overall income inequality in 1970 (before the NEP) could not be explained by various non-ethnic factors such as education. Anand concludes that, at most, only a corresponding share of income inequality can be attributed to ethnicity. His analysis implies there is limited scope for reducing overall income inequality by reducing inter-ethnic disparities. The NEP's primarily ethnic focus for over half a century is hence unlikely to significantly lower economic inequality in Malaysia. Unsurprisingly, despite over half a century of the NEP, total income inequality remains high, even if underestimated.

Equating “social justice” with efforts to reduce inter-ethnic disparities is problematic. Supported by and responsive to the newly emerging Malay “middle class”, the new Malaysian regime defined “restructuring society” as one of the two NEP targets. This has been mainly understood as “positive discrimination”, or affirmative action, along ethnic lines, to eliminate the identification of “race” with “economic function”.

Defining social justice in terms of achieving affirmative action policy is problematic. Such a definition also effectively rejects other possible interpretations of “social justice”, for example, in terms of “abolishing class exploitation”, or achieving low income or wealth inequality, or reducing disparities among different regions.

Sabah and Sarawak state rights within the Malaysian federation did not preoccupy Prime Minister Razak during 1969–1971. However, this omission in the NEP's ostensible social justice agenda is probably not acceptable to East Malaysians who believe they have not gotten a fair deal from the demographic majority in Peninsular Malaysia. Others might insist that overcoming gender and other inequalities is fundamental to any social justice agenda.

How do we compare other affirmative action policies, such as contemporary Black Economic Empowerment (BEE) in South Africa? What about pro-Afrikaner apartheid policies which also claimed to catch up with the previously dominant “Anglo-white” minority? What are the implications of such policies when introduced and implemented by demographically and politically dominant cultural majorities, as in South Africa, Malaysia, and, arguably, Hindutva India?

And how do we analyze similar policies in different contexts? For example, BEE in South Africa is generally acknowledged as being inspired by Malaysia's NEP. Ironically, BEE has since been re-imported into Malaysia as “Bumiputera economic empowerment”, even using the same BEE acronym.

And how does a society decide on what is a legitimate and acceptable social justice agenda? Who decides and how? Invoking notions of “equality” and “fairness” hardly resolves the difficult issues to be resolved. Affirmative action seems to suggest the acceptability of otherwise unequal societies in which aggrieved groups are proportionately represented.

It also begs the question of affirmative action for other aggrieved groups which are minorities or not politically dominant. What does social justice in India imply, especially for its scheduled castes and tribes? Or for US ethnic minorities, including the descendants of Native Americans or African American slaves? And when does addressing a grievance support “social justice”? After all, apartheid was seen as a means for Afrikaner “ethno-populists” to achieve parity with Anglo-South Africans.

After eloquently exposing the policy cul de sac the NEP is in, it is curious that Lee still insists “Malaysia needs a systematic and comprehensive reset of the NEP's (restructuring) prong”. This precludes a broader, more progressive approach to accelerate development more equitably. After all, in 1971, Razak already envisaged a Malaysian nation with comprehensive and universal social security.

References

Anand S. (1982). Inequality and Poverty in Malaysia: Measurement and Decomposition. Oxford: Oxford University Press.

Lee H.A. (2023). Social justice and affirmative action in Malaysia: the new economic policy after 50 years. Asian Economic Policy Review, 18(1), 97– 119.

https://www.ksjomo.org/post/comment-on-social-justice-and-affirmative-action-in-malaysia-the-new-economic-policy-after-50-year

Inflation targeting farce: High costs, moot benefits

Anis Chowdhury and Jomo Kwame Sundaram

SYDNEY and KUALA LUMPUR. Sep 20, 2022 (IPS). Policymakers have become obsessed with achieving low inflation. Many central banks adopt inflation targeting (IT) monetary policy (MP) frameworks in various ways. Some have mandates to keep inflation at 2% over the medium term. Many believe this ensures sustained long-term prosperity. 

The now universal 2% inflation target “was plucked out of the air”. This was acknowledged by Reserve Bank of New Zealand (RBNZ) Governor Don Brash who first adopted IT. The target was due to NZ Finance Minister Roger Douglas’ “chance remark” of achieving “genuine price stability, around 0, or 0 to 1 percent”.

IT discord

Heads of major central banks – such as the US Federal Reserve Bank (Fed), Bank of England (BoE) and German Bundesbank – committed to keep inflation at 2% soon after NZ. Although typically ‘medium-term’, IT’s high costs are portrayed as necessary, but brief. Worse, promised growth benefits have not materialized. 

The Articles of Agreement of the International Monetary Fund (IMF) never endorsed any fixed inflation target. Article IV states, “each member shall: (i) endeavor to direct its economic and financial policies toward the objective of fostering orderly economic growth with reasonable price stability, with due regard to its circumstances”. 

This makes clear much depends on conditions and circumstances. The sensible priority then would be to sustain prosperity with “reasonable price stability”, and not to commit to an arbitrary universal IT at any cost. Yet, many IMF officials promote the 2% target.

During the 2008-09 global financial crisis (GFC), the IMF Managing Director appealed for more imagination in designing monetary policy, appreciating “just how intricate the global economic and financial web had become”. 

For him, “Monetary policy needs to look beyond its core focus on low and stable inflation” to promote balanced and equitable growth, while minimizing adverse spill-overs on developing economies.

An IMF chief economist even asserted low inflation and economic progress was a “divine coincidence”, and insisted a 2% inflation target was too low. After the GFC, an IMF working paper argued for a long-run inflation target of 4% for advanced countries.

A Bank of Canada working paper concluded, “the current state of economic research – both empirical and theoretical – provides little basis for believing in significant observable benefits of low inflation such as an increase in the growth rate of real GDP”.

IT benefits?

Any objective consideration of actual IT experiences would have led to its rejection long ago. IT is clearly inimical to growth and equity, let alone the Sustainable Development Goals (SDGs). Four central bank (CB) experiences offer valuable lessons about IT’s likely consequences. 

The US Fed is, by far, the most important CB globally, while the BoE has been historically important. The Bundesbank has been the most inflation averse in the post-war period, while the RBNZ was the world’s IT pioneer.

NZ’s inflation during 1961-90 averaged 9%, more than the US’s 5.1% and the UK’s 8%. Yet, the mighty Fed and the venerable BoE sought to emulate the miniscule RBNZ! Germany’s well-known inflation-phobia is attributed to its inter-war ‘hyperinflation’ and its bloody aftermath. Inflation there averaged 3.4% over 1960-90, i.e., even before IT.

None achieved sustained economic prosperity despite reaching inflation targets of 2% or less. Average per capita GDP growth declined sharply in the US, UK and Germany, while rising negligibly in NZ (Table 1).

Table 1. Pre- & post-IT average per capita growth & inflation (%)

Long-term declines in their growth rates followed declining investments (Table 2). IT advocates claim high inflation causes uncertainty, thus reducing investments, but lower inflation has clearly done worse.

Table 2. Pre- & post-IT investment/GDP (%)

As the investment rate declined with IT, so did productivity growth in the UK, Germany and NZ (Table 3). While productivity growth has risen negligibly with IT in the US, it has trended down in all four economies (Figures 1-4). US hourly output grew at only 1.4% after 2004, “half its pace in the three decades after World War II”. 

Table 3. Pre- & post-IT productivity growth (%)

Figures 1-4. Declining productivity growth, 1990-2021

Most advanced economies have experienced productivity slowdowns since the 1970s. With the European Central Bank’s strict IT framework, the euro zone also saw marked slowdowns in productivity growth during 1999-2019. 

Declining productivity growth often becomes the pretext for depressing real wages and working conditions, compelling workers to work more to compensate for lost earnings. Productivity and growth slowdowns are seen as “secular stagnation”. 

All this has been blamed on inflation. But lowering inflation has not reversed this trend, which has actually accelerated since the GFC. Many explanations have been offered, but the reasons for this failure remain moot. 

IT, low inflation, tax cuts and market reforms are supposed to improve economic performance. Weaker investment and economic growth, due to contractionary macroeconomic policies, slowed US productivity growth.

Similarly, The Economist observed, “Drooping demand crimped incentives to invest and innovate”. It ascribed declining UK productivity growth to cuts in innovation investments due to “austerity policies” and “severe reduction in credit”, inter alia. 

Concluding “no doubt … the cost … was huge”, it estimated, “Britain’s GDP per person in 2019 would have been £6,700 ($8,380) higher than it turned out to be” had productivity growth not fallen further after the GFC. 

There is growing acknowledgement that widespread “unconditional” CB commitment to 2% inflation targets – in the face of the current inflationary upsurge – is likely to worsen slowdowns. This is likely to compound debt crises in many developing countries.

The adverse socio-economic impacts of recessions are well documented. Policy-induced recessions – supposedly to curb inflation – will compound the effects of pandemic, war and sanctions. 

Pragmatism, not dogma

Central bankers should not be dogmatic. Instead, pragmatic approaches are urgently needed to address the current inflationary surges. This is especially necessary when inflation worldwide is mainly due to supply shocks.

Western policymakers must consider the adverse spill-over impacts on developing countries, already on the brink of debt crises due to protracted slowdowns. Government debt – with more higher cost commercial borrowings – has been rising since the GFC, Western ‘quantitative easing’ and Covid-19.

Almost all central bankers know it is almost impossible to achieve 2% inflation in current circumstances. Yet, they insist not raising interest rates now will cause much economic damage later. 

But such claims clearly have no theoretical or empirical bases. Hence, it is recklessly dogmatic to enforce a 2% target by falsely claiming inaction would be even more harmful. 

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