For 10 years, economists wondered: why is inflation so low? Suddenly, in the last few months, they wonder: why so high? In the words of the Los Angeles Times, “Economists are getting a dose of humility on forecasting inflation” as prices rise “well beyond the expectations of Wall Street and policymakers.”1 Politicians, economists, and the Man in the Street are used to blaming inflation on Big Government; as Ronald Reagan put it, “inflation results from all that deficit spending.”2 So the absence of inflation when government responded to the Great Recession of 2008 by handing out money and letting deficits soar was puzzling.3 Whatever the current puzzlement at inflation’s reappearance, it is almost with relief that economists and officials are calling for a return to the old methods of deflating by partly closing the valve on the money supply and, eventually, raising interest rates. But nobody knows for sure what is going on.
This is only the most recent example of the disintegration of economic certainties during the last 40 years. What was called “Keynesianism,” the dominant economic doctrine of the postwar period, claimed that government action could produce an economy without mass unemployment or excessive inflation. This idea was rendered unconvincing by the stagflation (combined stagnation and inflation) of the 1970s.4 The “monetarist” orthodoxy that succeeded it, which insisted that the confinement of state interference to controlling the money supply would produce global prosperity and progress, went down in flames in 2008. Since then, in the words of political economist Robert Skidelsky, “We are at a point where the whole of macroeconomic policy is up for grabs.”5
Economic theory is hamstrung by assumptions that have shaped it since its origins in the eighteenth century. Adam Smith proclaimed consumption to be “the sole end and purpose of all production” in The Wealth of Nations (1776) and this idea, which can seem commonsensical, remains fundamental to the science. As Smith explained and economists still maintain, in a society of free individuals (not subject, for instance as slaves or serfs, to some ruling authority) self-interest motivates them to meet each other’s various needs by mutually exchanging the different kinds of things they make. Entrepreneurial types organize the production process as efficiently as possible in return for a share of the proceeds from market exchange; it is their wish to gain this profit that, as they compete with each other for buyers, drives increasing productivity and the expansion of social wealth. In this picture of the economy, money plays the role of a technical means for facilitating the complex web of exchanges. Since the goal of economic activity is consumption, it is goods, not the money that symbolizes their value, that are the real inputs and outputs of the system.
A new idea came with the late 19th-century remodeling of economics to look more scientific by imitating physics, with its sets of differential equations: If no factors external to the economy—such as bad weather, pestilences, wars, or other sorts of government interference—disrupt the system of production for the market, it settles into a state of equilibrium, stable because all individuals have made out as well as they can. Just because each individual seeks his or her own welfare, the system utilizes all available resources, including technology and workers seeking employment by entrepreneurs. Hence, unemployment is impossible. Equilibrium requires, of course, that the exchanges that hold the system together make mutual sense: thus wages must be set so as to make profits possible when goods are sold at prices that consumers will pay, while allowing workers to survive. But since consumption is the final goal of the system, and each individual chooses freely how to participate, abilities and wants—supply and demand—are adjusted to each other to maximize the satisfaction gained by society’s total effort.
That this picture hardly corresponds to the reality of modern economic life is obvious, which does not stop it from being taught in economics departments around the world. Apart from the dubious freedom of individuals forced to seek employment in order to survive, by the early 19th century the recurrent pattern of boom and bust now called the business cycle should have cast doubt on the existence of a tendency towards systemic equilibrium. Contemporary economics has adopted the terminology of “shocks” to explain breakdowns of the supposed equilibrium as due to unpredictable events impinging on the smooth operation of the economic machinery. But the empirical regularity and systemic character of such breakdowns suggest endemic causes. The bust periods make particularly evident the fact that consumption, far from being the ultimate purpose of production, is subordinate to the entrepreneurial demand for profit: goods not profitably salable are not produced or are even destroyed, like the food dumped to raise prices in the face of widespread hunger. Capitalists invest money in the hope of ending up with more money than they started with. Since investment is made in order to earn profits, and since the demand for labor (and thus for consumer goods) and production goods depends on investment, the ups and downs of the profit rate—the ratio of money earned to money invested—determine the well-being of the economy.
It was the experience of the Great Depression, with its lasting high unemployment, that led to acceptance of John Maynard Keynes’s 1936 modification of orthodox theory to allow for the possibility of less-than-full-employment equilibrium. In particular, he took seriously the idea that capitalism is a money economy, not just a complex barter system. He argued that economic progress brought a lower “propensity to consume,” since total money income increases more than desire for goods. This naturally limited the profitability of investment (since consumption is the goal of production), falling anyway as the amount of capital investment increased, and led wealth-owners to hoard their money instead of investing it. Production and so employment could then only be expanded by the state’s spending of tax money and, increasingly, funds borrowed from the private sector. This stimulus, priming the economic pump, would shift the equilibrium back to full employment.
Something like this, without the theory, had been put into practice by Adolf Hitler and President Franklin D. Roosevelt; Keynes’s theory provided a rationale for steps governments were already taking. World War II, in fact, could be thought of as a massive experiment in Keynesianism; indeed, at the cost of an enormous state deficit, the United States reached something like full employment during the war. Keynesian policies were continued after the war, to forestall a feared return to depression conditions. They worked, apparently, until the 1970s, when—to leading economists’ consternation—government deficit spending seemed to bring with it uncomfortable levels of inflation while failing to produce full employment.
It has long been noticed that price levels fluctuate along with general economic conditions. This is not mysterious: prices go up as demand for goods rises when investment and employment increase, and go down when demand falls in recessionary periods, forcing sellers to compete. Before World War II, inflation had only been a problem in its short-lived “hyper” form, when governments printed large amounts of money to finance warfare. The period since 1940, however, saw a constant tendency toward inflation. This became a worry for policymakers (President Dwight D. Eisenhower, for instance, opined that “economic growth in the long run cannot be soundly brought about except with stability in your price structure”6) because it affects foreign trade, transfers wealth from creditors to debtors—impoverishing those who live on fixed incomes or savings—and makes business planning more difficult.
Prior to the early 20th century, the money supply in each nation was supposed to be controlled automatically by the gold standard, under which the definition of money units in terms of quantities of gold was to limit the amount of currency issued by governments. It didn’t really work like that, but in any case, the international gold standard came to a definitive end in 1971, when President Richard Nixon cut the link between the US dollar and gold. Since then, the quantity of currency circulating in each nation is set by the national central bank—in the US by the Federal Reserve. Monetarist economics, which gained theoretical supremacy when Keynesianism lost its luster, held that price fluctuations, signaling imbalances between the quantity of money and the core economic phenomena of production and exchange, explain economic fluctuations. Milton Friedman, the American guru of monetarism, blamed the Great Depression itself on faulty monetary policy, and guaranteed an even-tempered economy if money was well regulated.
Alas, as Skidelsky puts it, “money refused to behave in the way Friedman said it should.”7 Constriction of the money supply by the Fed in the 1980s did succeed in taming inflation, at the cost of a serious recession, widespread bankruptcies, and high unemployment, but the ensuing period of quasi-prosperous price stability (the “Great Moderation”) led directly to the crisis of 2008. Even apart from this debacle, however, data show that the theory is wrong: rapid growth of money supply does not cause inflation, however plausible the formula of “too many dollars chasing too few goods.”8 Despite the blame put on Big Government, research also indicates that, for instance during 1961-81, “the notion that inflation occurred either in the United States or in the other advanced capitalist countries because of excessively high levels of government spending and large budget deficits receives little, if any, confirmation.”9 Yet it is not a coincidence that inflation has accompanied the expansion of government involvement in the economy since the 1930s.
In the United States, federal expenditures were about 2.5% of GNP in 1930; by 1965 they had risen to 18%, by 2020 to well over 45%. This expanding expenditure responded, following the Keynesian recipe, to the failure of the economy to grow at a rate and to an extent sufficient to employ the population of propertyless people dependent on employment for their livelihoods. By the mid-20th century, as wage labor became the dominant mode of life in “developed” and even “developing” countries, large-scale unemployment came to pose a danger of social disruption that the business elite found unacceptable. Hence, the worldwide proliferation of welfare programs, government spending on public works and war production, and public sector employment in such areas as health care, education, and the state bureaucratic apparatus as a whole.10
The money the government spends on all this comes almost entirely from taxation of and borrowing from the business entities making up the capitalist economy. If we think of wages as the amount of income workers actually receive, we see that taxes come from the money generated each year that could be appropriated by business owners, under such different names as profit, interest, and executive salaries. Taxes are also the ultimate source of interest that is paid on the national debt, and of the principal paid back. The business class and its Congressional representatives may be mistaken in blaming government spending for inflation, but they are certainly correct in their hatred of taxation. Government spending does not add to society’s profits, because the state is merely redistributing money taken from the private sector as a whole to particular producers (directly or through subsidizing consumption). While production and consumption are increased, capital investment overall does not grow. For business, the public sector is an expense. Its obsession with this issue, beginning with hostility towards the New Deal, bore fruit over time, with sizeable tax cuts purchased by budget deficits and a growing national debt.11
In the 1960s, economists began to register a decline in corporate profits in the US,12 though it was not until the next decade that the economy went into what was then the deepest recession since the 1930s. Despite the limitations of the profit rate, the economy was booming, thanks above all to the Vietnam War, with the highest industrial capacity utilization and lowest unemployment since World War II.13 When the recession came, instead of competitively cutting prices capitalists compensated for declining profitability by raising them, something made possible by the money injected into the economy to pay for war and social programs. The deficits did not in themselves cause the inflation by enlarging demand; both were responses to inadequate profitability. Every period of business expansion leads to the expansion of credit beyond the point at which returns on investment can repay the money borrowed; government fiscal policy extended this process into periods of downturn. Just as the over-expansion of credit—not the decline in profitability that is the fundamental issue—appears to be the source of business’s problems in a crash, so the expanding government deficit appeared to be the cause of inflation.
Fear of replaying the stagflation experience limited the stimulus and refinancing programs with which the Obama government responded to the financial crash and economic crisis of 2008. Nonetheless, a chorus of conservative “deficit hawks” insisted they would lead to inflation. The supposed connection between government money and inflation did not materialize. Many banks held an unusually large amount of the money received from the Fed’s Quantitative Easing program—buying Treasury bonds and other securities with newly created money—as reserves, earning a miniscule amount of interest from the Fed. This suggests limited demand for funds for productive investment; as in earlier decades, low profitability made investment in industry unattractive. Instead, money circulated in the financial system, replacing the trillions destroyed in the crash and pumping up the prices of stocks, bonds, real estate, and other assets. Official inflation stayed low, however, as consumer prices did not rise at a time when millions of people had lost jobs and homes.
That the recovery from the Great Recession, officially announced in 2009, was a low-profit one is suggested by the abysmal growth rates of the OECD countries 10 years later—with Japan at 1.6%, Germany at 0%, the U.S. at 2.3%—while non-financial corporate debt reached an all-time high of $6.6 trillion. As I wrote in this space in May 2020, “an economic recession was well on the way before the coronavirus tipped us over the edge.”14 The Fed responded to the COVID-exacerbated collapse with more infusions of money into the financial system, while Congress passed relief bills adding up to $5.2 trillion, with money for businesses and the unemployed. Now used to low inflation, economists and politicians breezily waved away worries about deficits. After all, the alternative was clearly a global economic catastrophe. Still, the deficit danger was invoked by those who opposed the “Build Back Better” bill proposed by the Biden administration, though funds continued to flow into the financial system.
After a year of this, the business class seems to have decided that enough is enough. COVID or no COVID, whatever the toll of illness and death, it’s time for people to go back to work, and for business to make money again. Expanded unemployment payments and monthly stipends for children have come to an end; “hero pay” for essential workers is no more; rent moratoriums are history. And the partial revival of economic life fueled by stimulus money (though employment is still down millions of jobs and labor force participation is still historically low) offers an opportunity for companies to make up for the lost year. It’s hard to see how the much-emphasized supply chain problems are causing rent increases (though I’ve seen a newspaper writer suggest this); a year of missed rent payments, together with the takeover of rental real estate by multinational venture-capital firms, might have more to do with it. But the supply chain problems are real—the COVID shutdown disorganized the global economy, and Omicron is not permitting a smooth reopening. Increases in energy prices (which had dropped radically during the shutdown), wholesale costs, and shipping costs are being passed along to consumers, lowering real wages.
The Federal Reserve stopped downplaying the significance of rising prices after the Employment Cost Index released on October 29 showed that wages and benefits were rising faster than expected (mostly at the lowest end of the scale). Even though wages are, as usual, lagging behind prices, this has been enough to revive worries about the wage-price spiral that is supposed to have enabled the inflation of the 1970s. It is certainly true that workers’ disinclination to accept lower pay does not help profit margins already under pressure. Accordingly, “Executives spent last quarter warning about higher wages and shipping costs.” Luckily, “In the end, many companies were able to raise their prices by as much as, or more than, the increase in costs … So even with the highest inflation in decades [sic!], reported profit margins are expected to be high—and rising.”15
While it is impossible to predict the turns and twists the inflation story will take in the near future, it is clear that the underlying problems that have manifested themselves since the 1960s in a multitude of forms—credit crunches, monetary crises, recessions, inflations, unemployment, and ever-increasing private and public debt—are not going to be resolved. The policymakers’ obsessive concern with inflation seems quaint at a moment when the acceleration of climate change promises a 1.5° centigrade rise in temperature by 2033 (and the heat in Australia has reached 123° F.); the water table is disappearing in India just as the government struggles to lay pipes to the country’s villages; hospitals are packed worldwide with COVID patients while the death toll mounts; and the world economy is unable to provide adequate food and housing to billions of people. The period since the 1970s has seen declines in productivity increases, new capital investment, and the general capacity to recover after downturns. In the face of what seems a definitive decline of capitalism as a world system, worries about price increases seem a little inflated.
- V. Golle, O. Rockeman, and R. Pickert, “Why economists got it wrong on U.S. inflation,” L.A. Times, November 11, 2021.
- Reagan’s Address on the State of the Nation’s Economy, New York Times, February 6, 1981.
- See “Money Magic,” Field Notes, Brooklyn Rail, October 2020.
- They shouldn’t have been so surprised: already the recession that began in 1957 was “superimposed on a long-range trend of inflation which was then almost twenty years old” (H. Stein, The Fiscal Revolution in America [Chicago: Chicago University Press, 1969], p. 344).
- R. Skidelsky, Money and Government (New Haven: Yale University Press, 2018), p. xvii.
- Answer at news conference, January 21, 1959, quoted in Stein, Fiscal Revolution, p. 354.
- Ibid., p. 184.
- R.W. Vague, “Rapid Money Supply Growth Does Not Cause Inflation,” PrivateDebtProject.org. W. Greider’s detailed account of monetarism in action at the Federal Reserve during the 1980s, Secrets of the Temple (New York: Simon and Schuster, 1989) provides evidence for the same conclusion in this classic case.
- D. R. Cameron, “Does Government Cause Inflation? Taxes, Spending, and Deficits,” in L.N. Lindberg and C.S. Maier (eds.), The Politics of Inflation and Economic Stagnation (Washington: The Brookings Institution, 1985), p. 279 .
- In fact, “The most immediate beneficiaries of the welfare state are those working in the program” (R. Klein, “Public Expenditure in an Inflationary World,” in Lindberg and Maier [eds.] The Politics of Inflation, p. 216).
- See Stein, Fiscal Revolution, for a detailed history of this process during 1932-1965.
- See, notably, W.D. Nordhaus, “The Falling Share of Profits,” Brookings Papers on Economic Activity 1974:1 (1974), pp. 169-217.
- D.R. Cameron, “Taxes, Spending, and Deficits,” p. 274.
- S. Gandel, “What to Expect as Corporate Giants Report Earnings for Fourth Quarter,” New York Times, January 14, 2022, p. B5.