In July 2021, I wrote a piece titled “The Great Deficit Robbery”. It was an article cautioning against the new orthodoxy emerging among many mainstream economists and politicians suggesting that government spending had no limits, and that the once scary bogeyman of inflation was simply a relic of the past. I wrote that ‘if constant spending persists with no guardrails in sight, economic trouble may be just around the corner.’ As we watch the global rise in inflation and the cost of living, it is worth investigating what factors are truly driving this rise and what lessons we can take to help shape economic policy in the future.  

Globally, inflation is on the rise. The UK has seen its inflation increase to heights of 10.1% with the US also seeing a rise to around 8%. The trend is similar in most countries around the globe but seems particularly acute in western nations. In the initial months of the crisis, it was suggested that inflation was a transitory issue but the Fed Chairman Jerome Powell has since admitted that ‘it is probably a good time to retire that word.’ The war in Ukraine and subsequent rise in energy prices has obviously been a major contributing factor to this recent hike but it is important to note that there had previously been significant inflation. As much as Joe Biden and Boris Johnson would like to place the blame of high inflation solely on this conflict, the inflation we are currently experiencing is a wider and more systemic issue than first thought, and a fundamental rethink of monetary policy may be required in the future.

Given the “easy money- low interest rate” era we have all just lived through, the first place to look at is excessive aggregate demand. This is the most obvious source of inflation and an area that the Bank of England and Fed are both looking to curb via the hiking of interest rates. The reasons why excessive AD causes inflation is well documented (and indeed I made the case in my previous article), so I will instead try and look at the factors driving this excessive aggregate demand. The stimulus provided by governments around the world is an obvious first contender. Another would be the pandemic and the extraordinary nature of the shutdown which meant that people shifted their spending away from services and towards goods (where a supply chain shortage led to runaway demand-pull inflation). This was compounded by low interest rates and previous household built-up savings. Given this is all a direct result of the pandemic it can be easy to assume therefore that no real reform of our system is needed, but as I argued in my previous piece: we have long been on borrowed time.  

For years, central banks have pursued a dual policy of low interest rates and Quantitative Easing (QE) to keep inflation at their intended target rate. Asset price inflation has exploded in the recent decades as it has acted as an escape valve for inflationary pressures caused by excess liquidity. Years of easy money meant that the economy was more vulnerable to inflationary pressures when an event like the pandemic forced governments to provide stimulus. While near-future tightening of monetary policy is inevitable, a focus on smaller, smarter government investment in the future may be wise.  

Another factor driving the rise in inflation is the supply-chain crisis. The average container now spends 20% more time in the system than it previously did, and this is causing a major build-up of congestion in ports and major supply-hubs. The basic demand for goods is being met via production but not by the logistics infrastructure currently in place as it is simply not fit for purpose. A frail supply chain combined with most goods being made overseas naturally means that countries are more vulnerable to external shocks such as a pandemic. Labour shortages have also contributed to the supply chain crisis. In what is being termed as “The Great Resignation,” the UK and US have seen an unprecedented number of workers quit their jobs and simply not return. Inadequate pay, working conditions and the search for better opportunities elsewhere are all thought to be contributing factors. It is a fascinating phenomenon, but also one which has led to decreased production or transport delays. A good example of this is the fuel crisis which occurred last year in the UK, where a shortage of available drivers meant that fuel was unable to be delivered to forecourts and led to worry that the supply of fuel would run out. Decreasing demand may curb inflation in the short term, however it won’t make us more cars, hats, or other goods. Thus, strengthening our supply chains is key in the future. 

Perhaps the most significant and recent cause of inflation is the war in Ukraine. Prior to the beginning of the war, the UK had an inflation rate of around 5% however economic sanctions have been imposed since then, raising the inflation rate in the UK to a whopping 10%! Russia is a major energy supplier to many European countries, and the economic sanctions imposed on her have meant that supplies of oil to these countries have been disrupted, thus increasing its price. Moreover, the war has led to a disruption of commodity exports like metals, grain, energy and gas. This disruption in supply naturally pushes up prices. Inflation is also a self-fulfilling cycle; if firms expect inflation, they will raise prices therefore leading workers and labour unions to demand wage rises helping to permanently trap inflation in the economy. Therefore, while it may be said that the war in Ukraine exacerbated inflation, it cannot be said to have solely caused it. 

This brings us on to the second focus of the piece. In the short-term, curbing demand may be wise, and this sentiment was echoed by Maersk (one of the world’s largest port operators) who warned in early September 2021 that the only way to ease the supply-chain crisis is for consumer demand to decline. In the long term however, policymakers must focus on economic policy which will be able to withstand future shocks from events like climate change. 

A proposal that has been floated around by some economists is an idea known as “QE for the people.” Traditionally, QE is undertaken by central banks who buy a predetermined amount of government bonds or other financial assets during a time when inflation is low in order to increase economic activity. However, QE can often disproportionately benefit the wealthy and corporations, with data from the Bank of England showing that 40% of the wealth transferred went to the richest 5% of British households. This has also raised questions concerning its actual effect on the economy, with Former Federal Reserve Chairman Alan Greenspan stating that “[QE has] very little impact on the economy.” Although there is evidence suggesting that QE has prevented deflationary spirals, the issue is that the side effects associated with QE outweigh its benefits. Due to the sheer amount of liquidity brought on by using QE, it can (and does) cause inflation in certain cases. Thus, a “QE for the people” is a more effective method of delivering the gains of QE without the side effects.  

The basic idea of “QE for the people” is similar to Milton Friedman’s “helicopter money.” It is essentially a proposal whereby central banks directly pay individuals sums of money to expand monetary activity. By giving money directly to individuals, central banks will be taking a “bottom-up” approach which will be more effective in increasing monetary activity as people will go out and spend that money in the real economy. Moreover, there is evidence compiled by economists Mark Blyth and Eric Lonergan which suggests that “QE for the people” would require a fraction of the amount of money used in standard Quantitative Easing. Thus, by focusing on smaller, smarter solutions during times of recession we can decrease the chance of inflation when shocks like the pandemic hit. 

Strengthening our supply chains is a primary focus that policymakers will have to consider going into the future. Obvious policies like risk assessment, greater regional cooperation, and improving processes within the system are all important, but a policy that is often not talked about is the offshoring of manufacturing jobs. Since 2001, approximately 3.7 million jobs were relocated from the US to China, with similar numbers for manufacturing hubs in the UK. During normal times this has not been a problem as it has provided businesses with cheap labour and consumers with low prices. During events like the pandemic however, reliance on foreign countries for goods means that we are more vulnerable to supply chain shocks. Moreover, with an increase in tensions between China and the West, it may be inevitable that we begin to bring back jobs. Bringing back jobs helps not only to reduce deprivation in previous manufacturing towns, but will also mean we are less vulnerable to shock events in the future. Becoming energy independent will mean that we rely less on foreign countries for our energy supplies, mitigating the possible effects of future shocks. 

Events like the pandemic will become more common as we move to the future. Large scale shocks from climate change are expected to far outweigh the disruption caused by the pandemic. It is not even certain that this pandemic will be our last, thanks to the ecological pressures of increasing meat production and globalisation which make diseases like COVID far more likely to spread. The next big shock is coming. Let’s hope our policymakers prepare for it!