7 Ways Policy Makers Should Respond to the Cost of Living Crisis
4) The increase in employment and wages does not necessarily generate price increases
Few terms have had as much influence on the central bank as the “non-accelerating inflation rate of unemployment” (NAIRU), the lowest unemployment rate at which inflation is expected to hold steady. The theory behind this concept is that if unemployment is low, attracting and retaining workers requires employers to offer higher wages, the costs of which they then pass on to consumers in the form of higher prices. Workers then demand even higher wages due to the rising cost of living and, as the labor market is tight, employers give in to these demands for higher wages, leading to further price hikes, etc. . the so-called “wage-price spiral”.
But the existence of a NAIRU is not confirmed by the data, which shows no observable inverse relationship between the unemployment rate and the inflation rate. Moreover, if it were true that higher wage costs were always passed on to consumers, the distribution of total national income between labor and capital would always remain the same – workers could never improve their position relative to capital owners. Historically, that has not been the case either. In reality, workers’ share of the economic pie grew over time after World War II, until it reversed course and experienced a secular decline beginning in the 1980s.
This does not mean that a wage-price spiral is not possible, but it requires three main conditions: (i) a strong labor movement, such that workers can mobilize to win higher wages; (ii) a high degree of market concentration, meaning that firms have the power to raise prices without losing customers to competitors; and (iii) policy makers who allow market concentration to persist and do not employ adequate tools to minimize price increases. Currently we don’t have a strong labor movement, but we do have a small number of gargantuan corporations dominating sectors such as energy, food, auto manufacturing, technology and banking, while policymakers politicians turn a blind eye to the abuse of corporate power. The fight against fears of a “wage-price spiral” should therefore focus on the fight against excess market power.
5) Environmental degradation ushers in a new era of heightened price volatility
Climate change and ecological degradation are pushing humanity into an era of profound instability and uncertainty in which prices will certainly not remain unscathed. Even the pandemic-related inflationary pressures we are currently experiencing can be attributed to environmental destruction, given that the emergence of COVID-19 was linked to the exploitation and degradation of natural ecosystems. Smaller-scale physical climate-related shocks are also increasingly affecting prices, as recently demonstrated by pasta shortages due to a poor wheat harvest following record high temperatures and droughts in Canada. Meanwhile, our dependence on fossil fuels exposes us to continued increases in energy prices.
All current drivers of supply-side price pressures, such as shipping disruptions and geopolitical tensions, will be severely exacerbated as environmental degradation continues to intensify. On the other hand, climate- and nature-related shocks could dampen demand, thwarting the supply-side drivers of inflation, but this would come at a major cost to human well-being and life. Going forward, environmental policy should also be seen as inflation policy. If we fail to tackle the climate crisis and ecological collapse, price changes will be far from the worst of our worries, but they will add to instability and suffering.
When it comes to climate change, central banks have primarily focused on the implications for the stability of the financial system, but they are also increasingly looking at how this relates to their price stability mandates. The Bank of England must now recognize that if it is serious about achieving its medium-term price stability objective, the best course of action is to direct credit away from volatile fossil fuels and towards a stable source of low-energy renewable energy. cost.
6) A wide range of tools are needed to manage inflation and protect the vulnerable
Inflation responses should view interest rate hikes as, at best, a last resort, and only if there is strong evidence of widespread inflation fueled by unusually high levels of demand. Aside from this scenario, there are a host of other tools and strategies on the table to deal with price increases. In the current environment, policymakers should consider a series of immediate short-term measures to ease the pressure on the cost of living, as well as longer-term structural changes to prevent a possible inflationary spiral.
In the short term, policy makers should focus on:
- Prevent excessively high price, for example by further capping energy prices. Public ownership in key sectors such as energy, food and pharmaceuticals would also minimize harmful operating prices and enable new business models consistent with a green and fair industrial strategy.
- Protect the poorest by upgrading benefits or paying direct cash transfers to the bank accounts of households in difficulty, protecting them from price increases deemed inevitable in the short term due to rapidly rising costs.
In the long term, the focus should be on:
- Increase production capacity in search of environmentally friendly substitutes by increasing public investments and redirecting credits towards green projects and infrastructures. This would make consumers less dependent and therefore less exposed to potential further increases in the cost of cars and dirty energy.
- Breaking excessive market power through stricter antitrust regulation, reducing companies’ ability to price predatory and decreasing the need for price caps.
- Falling demand among those who can most afford itfor example by taxing the rich, which would also help to avoid the deterioration of the climate and the price volatility associated with it.
There is no one-size-fits-all solution to managing price increases, so all of these options and more should be explored in greater depth if we are truly to navigate and manage price increases in a way that supports people and the planet. Expecting the base interest rate to do all the work is foolish, counterproductive and dangerous for the most vulnerable in society.
7) Several institutions are needed to implement these tools
We cannot continue to place all the responsibility for inflation management on central banks. Instead, given that headline inflation numbers are not very informative and that most of the tools discussed above are largely outside the purview of monetary policy-making, we need to question the very concept of “inflation targeting” by central banks. History is replete with examples of monetary and financial authorities acting in favor of industrial development rather than following narrow price stability mandates.
History also offers lessons on how other public institutions can be helpful in tackling price hikes. For example, President Roosevelt established the Office for Price Administration in 1941 and staffed it with 250,000 employees to identify and address sources of inflationary pressures. And in the United Kingdom, where “fiscal policy, propaganda, subsidies, legislation and administrative regulation” were all used as “weapons in British efforts to control prices” during World War II, several government departments government were responsible for monitoring and managing particular price changes. .
It is time to rethink the institutional arrangements that dominate modern economic policy. Closer coordination between government departments and the Bank of England is urgently needed to control inflation and drive the transition to a fair and sustainable economy.