There’s one person, wielding super-human power, who is at this very moment doing his best to strangle the Canadian economy. Just as we started recovering from two years of pandemic lockdowns, he is trying to smother our rebirth in its crib. Far from an enemy of the Canadian state, this person came to power with the full blessing of our government. This nefarious monetary murderer goes by the name of Tiff Macklem. You could call him “Macklem the Knife”. He is the Governor of the Bank of Canada.
In a society that kneels before the altar of economic growth, it is odd when the winds change and suddenly growth becomes a serious problem. When the Canadian economy added a surprising 108,000 jobs this past October, this good news story was tempered with concerns over an “overheating” economy.
With the Bank of Canada ramping up its key interest rate from 0.25% in March to 4.25% by year’s end – the fastest increase in Canadian history – it was hoped by Macklem and his ilk that the economy would be showing more signs of cooling by now. “Growth needs to slow,” said Macklem in a recent interview. Disappointingly, the economy seems surprisingly resilient. Maybe after two years of enforced idleness, people actually want to work and earn money.
Why does this central banker want to inflict suffering on Canadians, in the form of job losses and increased poverty? In a word: inflation. It simply means that prices are going up. Another way to look at it is that the purchasing power of the currency is going down – our money is losing value. It’s a simple concept, yet ideas about what causes it and how to remedy it vary widely. But one thing that everyone can agree on is that price instability – whether we’re talking about inflation or its even more devilish cousin, deflation (falling prices) – is a bad thing for almost everyone.
The people most hurt by rising prices are those with low or fixed incomes. Affording the essentials of life simply becomes harder. It also hurts anyone trying to save money for things like retirement or the down payment on a home. And while inflation may help those with large debts like mortgages – by eating away at the value of the money used to measure that debt – price instability eventually works its way into every nook and cranny of the market, distorting price signals everywhere. Once the expectation of inflation becomes entrenched, demands for higher wages inevitably follow suit, as workers understandably try to ensure their incomes keep up with rising prices. But rising wages add fuel to the inflationary fire, creating yet more inflation. This positive feedback loop is called the “wage-price spiral”, and it was the demon that central bankers saw fit to wrestle to the ground with sky-high interest rates in the 1970’s and ’80’s.
Tiff Macklem is determined to avoid repeating this history. In a speech he delivered to the Public Policy Forum in Toronto this November, he said:
Our priority at the Bank of Canada is to restore price stability. The overriding imperative is to ensure that high inflation does not become entrenched because, if that happens, nothing works well. This was the experience of the 1970s. The failure to control inflation resulted in high inflation and high unemployment. Labour strife increased as workers tried to cope with large increases in the cost of living. And ultimately it took much higher interest rates, and a severe recession with a large increase in unemployment, to rein in inflation and re-anchor inflation expectations. That is exactly what everyone wants to avoid.
The Bank of Canada’s main leverage point – like central banks around the world – is its overnight interest rate. This is the rate that banks charge each other as they move money between themselves on a daily basis. The Bank of Canada gets to set this rate, which sets the floor for interest rates the private banks charge their customers for loans. The higher the overnight rate, the more we pay in mortgages, car loans, business loans, credit cards, and other borrowing.
When interest rates rise, people borrow less, and overall spending declines. This reduces demand in the economy, exerting a downward pressure on prices. Since prices are basically set at the confluence of supply and demand, less demand for products translates into lower prices. This is how the Bank of Canada, with its hand on the lever of the overnight interest rate, hopes to control inflation.
Managing inflation has been the main job of the Bank of Canada since 1991, when it became only the second central bank, after New Zealand’s, to set itself that as its main goal. It aims for a 2% inflation rate – low enough that no one need pay it too much mind, yet high enough to give a cushion to the dreaded deflation. And since that time inflation has been remarkably stable, usually staying between 0 and 4%. We’ve had the luxury of being able to ignore it, for the most part.
That is, until the pandemic. The Covid shock initially sent inflation slightly below zero – into deflation territory – but when economies started to come back online in 2021, inflation began creeping up, pushing past 4% in mid-2021 and peaking in Canada at 8.1% in mid-2022. The latest data have it down slightly, at 6.3% – largely due to reduced gas prices.
Covid put an end to a 30 year golden age of price stability and low borrowing costs. Now, in addition to footing the bill for more expensive food, fuel and pretty much everything else, the average family will need to come up with an additional $1000 a month to meet increased mortgage payments, as interest rates climb to levels not seen in a generation.
And they’ll have to manage all this while more of them are thrown out of work. While Canada enjoyed record low unemployment this past summer, at 4.9%, rising interest rates will inevitably lead to job losses. Indeed, that is the whole intent. While record low unemployment “seems like a good thing,” said Macklem, “it is not sustainable.”
The idea is that a certain number of people – perhaps more than a million Canadians – need to be among the ranks of the unemployed at any one time, otherwise workers will be in too strong a position to bargain wages up, triggering the dreaded wage-price spiral of accelerating inflation. Karl Marx called this the “reserve army of labour”, and Milton Friedman the “natural rate of unemployment”. According to this outlook, “suppressing employment is the path to salvation” when it comes to taming inflation.
While reducing employment will naturally reduce spending and demand, bringing inflation down, some economists go further and believe that increasing wage pressures are a direct cause of inflation. They believe there is a shortage of workers – brought on by retiring boomers and restricted immigration during the pandemic – and that this has created a sellers’ market for workers. “Job vacancies,” points out Macklem, “exceeded one million in the second quarter—a new record.” All those unfilled jobs give workers unprecedented bargaining power, and they are using it – the thinking goes – to push wages higher, forcing companies to charge more for their products, thus fueling inflation.
But what is the tail, and what is the dog, and who is doing the wagging? While wages in the US have seen a 5.3% gain over the past year, prices have inflated more than 7%. Wages, far from driving inflation, appear to be playing catch-up at best.
According to economist Jim Stanford, central bankers pulled out “a 40-year-old hymnbook,” in 2022. “Developed after the wage-price spirals of the 1970s, that old-time gospel preaches that inflation is caused by overheated labour markets, greedy unions, and accelerating wages. The remedy is high interest rates to cool off spending, recreate a desirable cushion of unemployment, and restore enough fear and insecurity among workers to keep wages firmly in check.” He believes that workers are being sacrificed, not just to control inflation, “but more importantly to control workers.” In this view, inflation is being used as a smokescreen for class warfare, tamping down on worker power right at the moment they are seeing a glimpse of hope for the first time in 40 years of stagnant wages.
THE CENTRAL BANKERS OF THE WORLD – the Fed in the US, the European Central Bank, and our own Bank of Canada among them – see excess consumer demand, possibly coupled with a tight labour market juicing wages, as the cause of this inflation spike. In other words, too much spending and too few workers. Some argue that the over half a trillion dollars that the Canadian government injected into the economy to keep out of work people afloat during the dog days of the pandemic has stimulated demand beyond what the market can produce (although central banks have been injecting trillions through “quantitative easing” since the Great Recession without causing inflation). High interest rates are supposed to create less spending, which will in turn mean companies hire less, and more unemployment will force workers to accept lower wages, both of which should lower prices. Tiff Macklem calls this “the Plan“.
But others see the causes of this bout of inflation as not caused by excess demand, but by restricted supplies brought on by Covid and Russia’s war in Ukraine. Prices can go up either when demand increases relative to supply, or when supply falls relative to demand. If there’s more demand than supply for any given product, the end result is that people will be willing to pay more in order to secure their slice of the pie. Think of real estate prices in desirable neighbourhoods.
Dissident economists of this school of thought see interest rate hikes as misplaced. “Eight months of rising interest rates have not yet noticeably cooled Canadian inflation,” wrote Stanford in November. “This isn’t surprising, since post-pandemic inflation has little to do with things the Bank of Canada can control. It’s mostly caused by global and supply-side problems (pandemic lockdowns, droughts and floods, war in Ukraine) — things which aren’t affected by interest rates. But the Bank of Canada persists with its tightening, hoping to shrink domestic demand enough to offset inflation from those supply shocks.”
Economist Armine Yalnizyan thinks that the 20th century approach to combating inflation through interest rate hikes is, in the 21st century, “more of a gamble because the modern-day problem is not enough supply, not too much demand.”
Robert Reich (Labour Secretary under Clinton, professor, and prolific writer/commentator) believes it’s a healthy dose of both, writing that “inflation has broken out all over the world. It’s happened because of pent-up demand from more than two years of pandemic. And limited supplies of everything from computer chips to wheat, due to difficulties in getting the world economy up and running, along with Putin’s war in Ukraine driving up world energy and food prices, and China’s lockdowns against COVID.”
Both supply and demand are constantly changing, and it’s hard to say which one is having a larger effect on prices at any point in time. In a recent talk, Dr. Fadhel Kaboub, an Associate Professor of Economics at Denison University and President of the Global Institute for Sustainable Prosperity, talked of “a member of the Fed, this is from a couple of years ago, this is pre-pandemic, essentially admitting that for ten years after 2008, we’ve tried everything to target inflation at 2%, and we just realized that we have no reliable theory of inflation. Translation in plain English, we have no idea what causes inflation. This is the mainstream essentially accepting this.”
We know that prices have something to do with supply and demand, and we think that interest rates can sometimes influence these forces, but the economy is an unwieldy beast, and Tiff is pushing a panic button that a previous generation pushed nearly 50 years ago, and hoping for the same result.
MUCH AS MAINSTREAM ECONOMISTS see demand and wages working hand in hand to drive inflation upwards, heterodox economists tie together supply and profits as the real culprits. Referring to Tiff Macklem’s speech to the Public Policy Forum, Stanford wrote “that there’s no evidence wages are fuelling inflation: real wages have been falling, and workers’ share of GDP has shrunk. It’s profits that have surged to record levels, not wages. But the word ‘profit’ didn’t appear once in Macklem’s 3750-word speech.” (The word “wage” appears eight times.) And yet, “as a share of Canada’s gross domestic product, after-tax corporate profits have reached a 60-year high.”
According to a report from the non-profit Canadians for Tax Fairness, in 2021 “large corporations in all major sectors of the economy saw their profit margins substantially exceed 20 year averages, with many hitting record levels.” The report goes on to state that:
the key contributor to the jump in corporate profits is increasing prices. This report indicates that in 2021 corporations brought in unprecedented levels of profit largely by increasing what they charge for their goods and services. This allowed corporations to almost double profit margins in 2021 to 16%, compared to the 9% average for 2002 to 2019.
When corporations choose to raise their prices in order to boost their profit margins, they drive up inflation. While much emphasis is put on inflation being caused by government spending, the corporate pursuit of higher profits through price increases is a much simpler explanation, though more poorly understood and less discussed.
This misunderstanding plays into the hands of individuals, organizations and lobby groups pushing an austerity agenda. Such an agenda would have a range of negative repercussions on the Canadian economy, while benefiting only the very rich.
Despite claims of solidarity with front-line workers early in the pandemic, and soaring profits, top North American companies “spent five times more on dividends and stock buybacks than on all additional pay for workers,” according to a Brookings Institute report.
Robert Hockett, a professor of law and finance, believes that there was an initial transitory price inflation caused by pandemic-induced supply blockages, but that firms with “abusive market power” then hopped aboard the price-raising bandwagon and engaged in opportunistic profiteering, catalysing inflation for the longer term. A survey of retailers by Digital.com bears this out; a staggering 56% admitted that “inflation has given them the ability to raise prices beyond what’s required to offset higher costs.” How many more did so but didn’t admit to it on this survey?
In an opinion piece in the Financial Times, the Chief Economist at UBS Global Wealth Management, Paul Donovan, writes that “today’s price inflation is more a product of profits than wages.” He goes on to argue that “wages have been rising but prices have been rising faster, so real wage growth is catastrophically negative. This is far removed from the 1970s-style wage price spiral [when] US real average earnings rose for much of the decade.”
Some commentators even question the received wisdom that the 1970’s inflation crisis was caused by a wage-price spiral, and that high interest rates were what eventually tamed it. Dr. Kaboub claims that the true cause of inflation in the 70’s was the OAPEC price shock, when, in 1973, the Arab oil producing countries, enraged at considerable Nixon-led US military support for Israel during the Yom Kippur War, placed an embargo on oil exports to the US and its allies, and instituted production cuts, causing the global price of oil to triple in a mere five months. In 1974 the new president Gerald Ford declared inflation, then at 12%, “Public Enemy No. 1”. But it was Jimmy Carter’s Camp David Accords, four years later, along with his deregulation of the natural gas industry, that brought inflation under control, not high interest rates and austerity.
Identifying the true sources of inflation can be as contentious as how to deal with it. In a Levy Economics Institute paper, authors L. Randall Wray and Yeva Nersisyan argue that interest rate hikes are targeting the wrong things. Transport and housing accounted for about 4% of the 7.4% inflation in the US in the winter of 2022, yet “people do not usually borrow to buy fuel for their cars, purchase groceries, or pay rent—the categories currently driving inflation. Indeed, raising rates can even be perverse by reducing home purchases and pushing up rents.” High interest rates can also be counter-productive by “cutting interest-sensitive spending, such as investment, [which] would work to constrain our capacity to produce (i.e., supply) in the future.” If a lack of supply is the real cause of inflation, then anything that acts to reduce that supply further, such as high interest rates, could exacerbate the problem; unemployed workforces produce less. Higher borrowing costs are also inherently inflationary. They warn that the Fed’s policy could produce stagflation – that lethal combination of high unemployment and high inflation, last seen in the 1970’s.
Dr. Kaboub thinks that “the focus should be on the actual sources of inflation pressure points… you target your strategy to tame the sources of inflation rather than just manipulate interest rates and blindly implement austerity across the board in a kind of collective punishment for the whole economy.” Raising interest rates is like chemotherapy for inflation; it’s a broad spectrum medicine, suppressing both supply and demand, when what is needed is a more targeted supply-side stimulus. He believes that targeted government investments that boost the real productive capacity of the economy can actually be anti-inflationary, because they boost supply – an idea he admits would “short circuit” the brains of most mainstream economists.
As the pandemic brought into sharp relief, our “just-in-time” supply chains are quite vulnerable to small supply interruptions. Many are now advocating a shift to “just-in-case” supply – a more resilient approach that moves away from globalization’s obsession with off-shoring production and relies on “on-shoring” (making it yourself) or “friend-shoring” (getting it from friendly neighbours) – which should cause less supply-push inflation when the next global crisis hits. Governments could also stockpile critical supplies, as they do already with some commodities, and release them slowly when supplies are low, thus modulating inflationary pressures.
Boosting domestic productive capacity is a great positive solution to inflation – rather than knee-capping the economy through interest rate hikes, it seeks to build it up. But it is a longer term solution. What can we do right now to deal with the acute crisis? Robert Reich, who once wrote a book called Saving Capitalism: For the Many, Not the Few, proposes “a temporary windfall profits tax on oil and food companies, temporary price controls on pharmaceuticals, bolder antitrust enforcement, a tax on stock buybacks, and higher taxes on the wealthy.” If high interest rates are in a sense a flat tax on everyone, rich or poor, wouldn’t it be better to just tax those who can afford it? Any tax pulls money out of the economy, and is therefore anti-inflationary; it’s just a question of whom we tax.
Jim Stanford doesn’t think we really need to do anything about inflation, because it is “already coming down, as the global disruptions that pushed prices skyward reverse themselves. Shipping costs, energy prices, and many minerals and agricultural prices have fallen steeply in recent months.” Just tame the monopolistic pricing of the corporations causing inflation, and stop making the cure worse than the disease with rate hikes.
BUT THE GOLDEN AGE of low and stable inflation may be over. Several factors conspired over the past 30 years to keep prices low: a plentiful supply of cheap goods from China, a large workforce of baby boomers, and a climate less prone to extreme weather events. But all those factors are changing, as more Chinese enter the middle class and cheap factory labour dries up, baby boomers retire in droves and labour markets tighten, and an unhinged climate wreaks havoc on transportation networks and food production. We could be in for a protracted period of steadily rising prices.
If this is the case, central banks, and the governments that ultimately stand behind them, are going to have to come up with more plays in their playbook than Tiff Macklem’s “Plan”. The Plan may work – probably will work if carried on long enough and with enough determination – but at what cost to people’s lives? Just because one approach works doesn’t mean that others wouldn’t work better, with less collateral damage. Why must labour be made the sacrificial victim, again, instead of excess profits? Why try to tamp down demand when you could increase supply instead? We need a Plan B.
Henry Ford, despite his many failings, did understand that it was in his own self-interest to pay his workers enough to afford his products, and to give them the time off to enjoy them. We now live in an economy where the success of a business is directly tied to people’s ability to buy its products. Business prosperity and worker prosperity are two sides of the same coin. Economies are not some force of nature beyond our control – they are constructs of the laws and policies that shape them. We can either choose to live in an economy that increasingly concentrates wealth at the top, or we can live in one where everyone has enough money to enjoy a good life – and the wealthy will be even richer because there will be more people who can afford their products.
Conventional economic thinking, mired in neo-liberal worldviews passed down from 19th century Anglo philosophers, sees things as zero-sum, prides itself on being a “dismal science” saddled with the responsibility of making hard trade-offs, and is fond of saying things like “there’s no such thing as a free lunch” (they even have an acronym for it: TNSTAAFL).
But free lunches abound. One example is the unemployed. Are they idle because all of society’s needs are already being met? No, we have no work for them because we are lacking enough numbers on a screen with a dollar sign in front of them. It’s like saying we can’t measure a piece of lumber because we don’t have enough inches. The government could put these people to work doing useful things, either through a centralized job guarantee program, by giving grants or zero-interest loans to entrepreneurs to create the needed jobs in a more decentralized manner, or in many other creative ways.
To this the old economic thinkers will scream, “But government spending is inflationary!” But it is not, so long as the money goes towards creating more productive capacity. One way inflation can happen – the monetarist view – is that too many dollars are chasing too few goods. It’s another way of saying that demand is outpacing supply. But if those new dollars spent by the government into the economy (and they create them out of nothing, by the way – see Modern Monetary Theory) create a concurrent rise in supply, then there’s no inflation. This is how we can break out of the “wage-price trap“. Forget the “spiral” – the “trap” is the orthodoxy that tells us we can’t have full employment or good wages because the economy will get all flustered and (oh my!) overheat, and will have to go take a cold shower.
As long as we have an economy where rising wages and spending creates inflation that can only be fought by suppressing wages and spending, we will be stuck in this trap. We need to re-envision collective provision – what we call the economy – from an old story in which some need to suffer in order for others to succeed, to one where individual and collective well-being are one and the same. When that other person, other community, other nation does well, I/we benefit too. Together, we can lift ourselves so much higher. Forget about class warfare – this is a battle between humanity’s best and worst selves. How we choose to deal with inflation going forward will say a lot about which self has won out.
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