Understanding Inflation

This incisive talk by Dr Phil Armstrong cast a penetrating light on current economic theory and practice, with special regard to the causes of inflation and methods of tackling it. Dr Armstrong’s own special area of expertise is Modern Money Theory, or MMT. Now might be the time for some iconoclasm, or at least some questioning thinking?

When they hear the word ‘economics’ most non-experts experience a strong desire to think about something else. But the economy – how governments manage it, how and why inflation comes about, and how it impacts us in the ‘real world’ is of critical importance to everyone’s wellbeing. At a time when UK inflation is running at a 30-year high of some 6%, we need to watch over the economic forces that so powerfully shape our lives.

A leading advocate of MMT, Dr. Armstrong pulls no punches when it comes to rubbishing the established received economic wisdoms, especially when it comes to the causes of and remedies for inflation. His first target is monetarism. Armstrong describes the monetarist assertion that all inflation is explained by excess government spending as ‘dodgy economics based on a dodgy right-wing ideology.’ He cites the Thatcher government, in particular, for its serial failure to prove that the money supply (MS) was a direct driver of inflation. In fact, despite inventing all sorts of economic ‘measures’ – M1, M2, M3, M3C etc – they were never able to establish a link between the MS and inflation.

The idea that Quantitative Easing (QE) is to blame for inflation is also roundly scotched. The government is not ‘printing money’ in a void, as mainstream media outlets frequently assert. Instead, Armstrong argues that QE sees governments exchange assets they already own (bonds, etc) for cash, much of which then goes to privately-owned banks. The banks can obviously lend unwisely in such a way as to drive asset bubbles, noticeably in mortgage lending and housing. Unless the government places conditions on the money supply, they are free to do what they want with it. Japan, Armstrong points out, has employed QE for the past three decades without any noticeable rise in inflation.

Instead, Armstrong asserts, inflation is the result of complex ‘cost-push’ factors that are largely outside governmental control. In our own times, for example, these include: firstly problems of supply caused by the pandemic and the current war in Ukraine hampering production and distribution. Secondly, what he terms the ‘oligopolies’ – big businesses like utility companies operating what is in effect a cartel to exploit customers. Thirdly, state actors like Russia and Saudi Arabia artificially constraining oil and gas supplies. As a qualified last come unions, where these still have power.

In this lecture Dr Armstrong also attacks the received idea that raising interest rates can help control inflation. This assumes that it is caused by consumer spending. The opposite, he believes, is true. He argues higher interest rates add income to the economy, while lower interest rates remove it.

Many modern economists have abandoned monetarism in favour of the idea that inflation is driven by the ‘expectation’ of inflation. Armstrong dismisses this as utterly wrong-headed: it is the other way around. Expectations do not generate reality, they are driven by reality.

What then, if this view is right? If we recognise that inflation has multiple and complex causes, and will not be defeated by any one-size-fits-all policy like monetarism, raising interest rates or the Quantity Theory of Money (QTM), Modern Monetary Theory suggests we may need to flex. We may need different policy approaches in different circumstances. In the current global climate of economic and environmental uncertainty, measures might include: bringing production of our goods, power generation and foodstuffs back onshore wherever possible to make ourselves less vulnerable to supply chain disruption; and creating a state-sponsored ‘buffer’ pool or stock of ‘job-guaranteed’ (JG) employees who would be ready to work at a fixed wage, which would increase or decrease in line with supply and demand.

This last proposal is harder to understand than most of what Dr Armstrong’s had to say in this discussion. But the whole falls into the class of essential listening, if we want to gain a better grasp of economic forces.

Rider: Dr. Armstrong’s theories are his own, and not those of WIBF. This is one in a series of lectures designed to equip women in business and finance – and people everywhere –to question the workings of the modern world.

Dr. Philip Armstrong is author of Can Heterodox Economics Make a Difference? Conversations with Key Thinkers. (Edward Elgar Publishing, 2020).

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