The flaws of contemporary monetary policies: is there a way out?
Giuseppe Mastromatteo
Full Professor, Catholic University of Milan, Italy
and
Sergio Rossi
Full Professor, University of Fribourg, Switzerland
Monetary Policy Institute Blog #96
“To achieve all these objectives, policy makers must coordinate their interventions in order to stabilize interest rates without leading to a recession through a variety of instruments such as price controls that most affect the consumption of the less well-off (notably energy, food and services of collective public interest, such as healthcare and education), fiscal policy, and the various forms of concertation and incomes policies that make it possible to determine wages, profit margins and public tariffs in a co-ordinated and co-operative manner, also with the aim of keeping inflation under control.”
Contemporary monetary policies across the global economy are deeply flawed. These flaws concern both the alleged factors of current inflationary pressures and the pretended benefits of the implemented interest rate hikes, particularly in the United States and European Union countries.
In the aftermath of the COVID-19 pandemic and the economic consequences of the war in Ukraine, the global economy has been affected by an on-going mushroom growth of prices across the market for produced goods and services. Contrary to the monetarists’ claim, this phenomenon is neither the result of those expansionary monetary policies that central banks across the world put into practice after the global financial crisis of 2008, nor due to excess demand on the product market. In fact, current inflationary pressures are the result of firms’ increases in their mark-up, particularly in those economic activities where the lockdowns in various countries or the energy and food disruptions along the supply chain have provided a unique opportunity to maximize these firms’ profits.
Now, central banks continue pretending that their interest rate hikes are not only necessary but also effective in reducing inflationary pressures, as the measured rate of inflation begins to show a slight reduction in a variety of countries, notably in Europe and the United States. In fact, owing to the long and variable lags of the monetary policy transmission mechanism, this reduction of measured inflation cannot be ascribed to central banks’ interventions, but to the recessionary forces the latter have been inducing across the global economy. As a matter of fact, all Western countries are more or less in trouble with regard to economic growth and employment levels, owing to distributional conflicts about income and wealth that result from the so-called “sellers’ inflation” — an expression used by Isabella M. Weber and Evan Wasner in their recently published article in the Review of Keynesian Economics. It is indeed the post- Keynesian school of thought in economics that has pointed out the essential factors of current inflationary pressures across the global economy: profit-driven inflation has nothing to do, in fact, with the alleged price–wage spiral that central banks want to avoid through their further increases in policy rates of interest.
As Ilhan Dögüs has explained cogently in this blog, firms’ market power allows them to push up their selling prices exploiting to their own advantage the possibility to increase their mark- up, hence also the profit share of national income, considering also that wage earners have no possibility to make sure their purchasing power is not affected negatively thereby. To be sure, the European Central Bank Economic Bulletin published in 2022 points out that the standard of living for a representative wage-earner in the euro area was 5 per cent lower than in 2021 — a situation that apparently contrasts with the increase in nominal wages, which, however, are reduced in real terms, once one takes into account the higher increase in consumer prices that weighs particularly on the living standard of poor and middle-class people.
This problem is further exacerbated by the on-going increases in the policy rates of interest as the latter are transferred to the interest rates that small and medium-sized firms pay to borrow from the banking sector the amount they need to pay their production costs. The majority of these firms will then transfer on their selling prices these higher borrowing costs, thus further increasing the measured rate of inflation, thereby creating a vicious (monetary policy) circle.
These flawed central banks’ decisions originate therefore distributional conflicts between the different categories of economic agents that lend or borrow and that produce or consume in a framework of a global economy that is highly financialized. As regards the conflict between creditors and debtors, rising the policy rates of interest implies that debtors suffer a reduction of their living standard, since they have to dispose of a higher amount of their income to pay interest on their debt, while creditors holding financial assets suffer a reduction of their price, which occurs across the marketplace — particularly when financial institutions sell their assets to avoid income losses deriving from monetary policy tightening. These issues show the need to rethink monetary policy interventions afresh and to coordinate them with fiscal authorities, considering the general interest for the common good.
To be sure, rather than continuing increasing their policy rates of interest, which has several negative effects and cannot curb actual inflationary pressures, central banks should support fiscal policies, as the latter can be targeted to the real needs of a variety of stakeholders. For instance, fiscal authorities may implement temporary price controls in those activities whose firms have increased their mark-up without any economic justification, just to maximize their profits taking advantage of their own market power. Further, fiscal policy can also impose the rents obtained by financial institutions as a result of their speculation, particularly in the food and energy sectors, where prices have been increased in the aftermath of the war in Ukraine. These fiscal revenues could then be used to support those individuals who are most affected by the observed increases in consumer prices, particularly as regards the bottom and middle- class people.
To achieve all these objectives, policy makers must coordinate their interventions in order to stabilize interest rates without leading to a recession through a variety of instruments such as price controls that most affect the consumption of the less well-off (notably energy, food and services of collective public interest, such as healthcare and education), fiscal policy, and the various forms of concertation and incomes policies that make it possible to determine wages, profit margins and public tariffs in a co-ordinated and co-operative manner, also with the aim of keeping inflation under control. This policy mix alternative to the actual “New Consensus” can avert any further social conflicts resulting from income and wealth distributional issues — without imposing that the poor and middle-class wage-earners reduce their living standard. If so, then “sellers’ inflation” can provide an opportunity for a radical change in both economic policies and firms’ activities, disposing of income as well as wealth distributional conflicts in the general interest for the common good.
