The political economy of inflation

I owe Fritz Machlum, an Austrian-born American economist for the caption of this paper. Machlup, a noted economist who died on January 30, 1983, presented a paper on ‘The Search for Stable Money at the luncheon talk given on January 22, 1983, at the Cato Institute’s conference. His paper was subsequently published in his honour in Cato Journal. Stable money manifests consistency in purchasing power of money or the value of money that is reciprocal of the price level. Machlup’s discourse covered many issues on the impact of inflation in the economy that bears political linings: inflation - unemployment trade-off, the modalities of addressing the problem of inflation; the exigences between stopping inflation gradually or instantaneously.

The idea of the link between inflation and politics flashed in my mind in the changing socio-economic perspectives of the Covid-19 pandemic. Nevertheless, it is rather difficult to define the domain of political economy. However, Machlup’s paper, though written in the early 1980s still remain very much relevant even in this current environment. Machlup’s definition of political economy encompasses many dimensions such as inflation, a monetary or fiscal phenomenon, a labour market, or a sociological problem. It also questions whether inflation is a distributional and or a psychological problem? The political alignment is manifested in Machlup’s paper, “Because either you have the inflationists in the administration or you have them in the opposition. If you have them in the opposition, the administration must make concessions and compromises. If it does not, it will be voted out of the office and the opposition with its inflationary program will get back in.”

Inflation was a problem in the United States during the 1970s; the average price level rose by seven per cent per year, a doubling of the price level over the decade. The public considered such a high rate of inflation derogatory. Indeed, when President Jimmy Carter ran for re-election in 1980 with the slogan that inflation is the number one enemy of the economy, the Republican candidate Ronald Regan in his election campaign highlighted the failures of Carter’s economic policy on containing the inflation surge. There is another chemistry in this political business cycle; the appointment of Paul Volcker as the Chairperson of the Federal Reserve in 1979 who moved to contract monetary policy to contain high rates of inflation [implicit in the exigency between stopping inflation gradually or instantaneously]. “The predictable result of Volcker’s decision was a recession, and the predictable result of the recession was a decline in Carter's popularity.”

The Misery Index; the sum of unemployment and inflation exceeded the tolerance level; on October 31, 2019, the index was 5.364 but the index on October 31, 2021, reached the record level of 10.82; a historic high level. It is often said that “Unemployment is too high a price to stop inflation.” Frédéric Bastiat once wrote: “The state is the great fictitious entity by which everybody seeks to live at the expense of everyone else.” and there indeed lies the dilemma.

The spectre of inflation is now haunting the global economy. It has engulfed both the developing and the developed world alike. The United States, Singapore, India, and Bangladesh all are in the grip of inflation with features defining the domain of political economy. With rising prices of food and fuel; inflation is now a political issue in all the countries. The Consumer Price Index registered an increase of 6.2 per cent, the highest inflation in more than 30 years in the United States. The US inflation may be frightening in the aftermath of a wage increase fuelling both inflation and inflationary expectations. Though there is an expectation that the annual inflation would retreat to two per cent by the second half of 2022, the current trajectory bids a different picture with the role of both Federal Reserve Chair Jerome Powell and the Treasury Secretary Janet Yellen. However, there may be a quirk here in the reappointment of Jerome Powell or his replacement by Lael Brainard. Janet Yellen owns the unique distinction in the world both as the predecessor of Jerome Powell as Federal Reserve Chair and now as Treasury Secretary to judge whether inflation is a monetary or fiscal problem. This is with reference to the $ 1.75 trillion bills on an array of social services known as Build Back Better and $ 1.2 trillion on infrastructure. “The infrastructure and Build Back Better packages are spending that’s really small relative to the economy in any year and spread over ten years.” Janet Yellen asserts that it will boost the economy’s potential to grow and soothe an inflationary spiral. However, Republicans and centrist Democrats have pointed to already high inflation with a request to scale back.

The cost of living of the poor and middle-income population in Bangladesh is strained owing to the recent price hike of food and fuel and other daily necessities. During the last three months, the change in CPI was 3.41 per cent, and the 12 months’ average is about 5.54 per cent. The Consumer Price Index in Singapore, driven by higher electricity and gas prices, continued to rise during the last six months. The IMF projections of inflation in emerging and developing countries will reach 5.50 per cent by the end of this year instead of 5.10 per cent in the last year. Bangladesh trails with IMF projections with minor deviations demonstrating the resilience and robustness of the economy.

The more poignant political elements in the developing world are given by the distributional, psychological, or ideological fabrics where the consequential impact of any policy changes without consultations to stakeholders could derail many positive outcomes in the process. Thus, timing and the philosophy in the decision-making process are of paramount importance in mitigating the psychological stresses owing to the inflationary pressure. A case in point is the recent decision of the government on the price hike of fuel. The government could have embarked on periodic increments instead of just one-shot increase.

The writer is the Treasurer and a Professor at the School of Business and Economics, United International University. He may be contacted at obaidur@eco.uiu.ac.bd