Inflation: the real problem

Everybody says we have an inflation problem. Everybody is wrong. What we have is a relative price problem.

The biggest reason for high inflation is that petrol prices and utility bills are soaring – up by 22.3% and 23.1% respectively in the last 12 months, contributing 1.5 percentage points to February’s 6.2% CPI inflation.

Imagine, though, that prices in the rest of the economy were flat, so that inflation were below its 2% target. Would everything be OK? No. We would still be handing over a bigger chunk of our incomes to monopolistic utility companies and to foreign despots.

What we have is a relative price problem. And this is a real problem in the sense that it’s a transfer of real resources.

This echoes an old phenomenon, described by David Ricardo in 1815. As the economy and population grow, he said, farmers would have to cultivate less and less fertile land to meet demand for food. That, he said, meant that food prices would rise over time. Which would squeeze real incomes and thus eventually kill off growth. It would also mean, he said, that owners of the best land could charge higher rents and prices, thus transferring income from renters to themselves.

Ricardo’s theory was wrong for food; thanks to trade and technical progress (two similar things) their prices fell after he wrote. But the gist of it was right. We are transferring a growing portion of our incomes to a different type of rentier – owners of utility companies and gas and oil reserves*. And this is not merely a short-term problem: in the last 20 years, gas and electricity bills have doubled relative to wages**.

This threatens to have the same effect that Ricardo predicted. If we are handing all our cash over to utility companies, we’ve nothing left to spend in more dynamic sectors. And so growth will slow. This is a version of Baumol’s cost disease.

The OBR thinks we’ll escape this fate this year because households will respond to the squeeze on incomes by saving less and borrowing more: it foresees the savings ratio dropping to a 60-year low. Even if this happens this year (which is questionable) it still leaves us with a longer-term problem. Stagnant productivity, a rising relative price of services (not least of which are government services) and the fading away of the effect of cheap imports from China all threaten to continue to squeeze real incomes. If fuel and utility costs continue their long-term uptrend, the squeeze will only be worse.

So, what’s the solution?

We should accelerate decarbonization. As Eric Lonergan and Corinne Sawers point out, this requires more than tax changes. It requires a greater availability of alternatives to carbon-based fuels and greater ease in switching to them.

There’s also a case for nationalizing utilities and oil companies so that their rents are socialized and could be recycled back to us. This would prevent the growth-depressing transfer of real resources that Ricardo feared.

Neither of these, however, fully solve the problem. As long as productivity is stagnant, so too will be real incomes. Which means that any big change in relative prices where demand is inelastic will cut someone’s real income.

Which brings us back to what all sensible economists have been saying for years – that our fundamental problem is a lack of productivity growth.

* And not just these: Ricardo's theory also applies to prime commercial and residential land. 

** The course of oil prices in is trickier. Although these are much higher now relative to consumer prices than they were at the start of the century, they are much lower than they were in 1980.  

 

Comments

[jim]

Ahh productivity, that old chestnut. The idea that somehow we can get more and more out of a body forever and ever. Perhaps some new gizmo to make their arm go faster or a spot of AI to amplify their brain. Fair enough, but those same tools will be round the world in a nanosecond or three and the effect will level out pretty soon.

What seems to happen is that when some group of people is made more productive some other group using that group's increased productivity is able to step off the treadmill and coast. Now they may use that time to think or figure out a better mousetrap and re-enter the productive race. Or they may invest in a string of BTL properties or suck up for a sinecure. Such idle, attractive and long lasting schemes seem likely to reduce the overall productivity of our imaginary society as more and more drop out and suck up.

That seems to be the blessing of revolutions, you need one every century or so to flatten the pimples and level things up (or down) a bit.

Or we can claim Oh, a bit more education will solve our problems. This is just victim blaming, you would have a decent job, but you are too thick. Now of course no-one is going to deliver an Eton/Harrow/Oxford education to everyone because that would just spoil the game. No longer worthwhile for the elite to spend on their kid's education to get the better sort of job. Because it is not at all obvious that the elites are truly smarter than the oikos but they do speak nicely and fit in. The game is not in the teaching but the fitting of pegs to elite flavoured holes.

The fundamental problem is allowing people to drop out and coast - or do well as we say. All the way back to Jane Austen and before that is the way nice people want to go. So come along Sir Joshua and family, you've had it too good for too long, back to the dark satanic mills and council flat for you. Clogs to clogs in three generations - with no exceptions, do-wellers included - courtesy of the New DSS. I can hear the screaming from here.

'Productivity' and 'Education' are a fig leaf covering up a more basic problem. Noble things in their own way but we need to dig a bit deeper before declaring that more of them is the answer.

[rsm]

Why not simply index everything, as Turkey is doing with lira deposits? Why not use the demonstrated force of central bank liquidity to give everyone gas cards, as California and House Democrats are currently proposing?

What if rising prices don't reflect physical scarcity but rather money demand (thus an imposed, artificial, unnecessary scarcity of money)?

Is it too heterodox to see GDP growth as a politically value-laden figure that is as arbitrary as the prices it measures?

[nick j]

stagnant productivity and stagnant real incomes - what's the problem with that? the real problem is distribution imo.

[LJC]

Nationalisation of utilities and oil companies is not the answer. The author, of all people, should know that the value placed on a company is the discounted sum of its future profits stream, so all we are doing by nationalising is paying a capital sum in return for that profits stream which, if the company is valued correctly will be exactly equal. Now, if he had written expropriation instead, his remarks would have been applicable.

[Blissex]

«If fuel and utility costs continue their long-term uptrend, the squeeze will only be worse. [...] It requires a greater availability of alternatives to carbon-based fuels and greater ease in switching to them.»

That's a very clever "non-sequitur, switching from "costs" to "availability" and "ease in switching".

«So, what’s the solution? We should accelerate decarbonization.»

And here with a vigorous wave of the hand our blogger fantasizes that decarbonisation will both make energy cost less than with current fuels *and* will also reduce imports. Because otherwise decarbonisation will lead to a bigger relative price problem.

The usual argument for decarbonisation used to be something like "while energy will cost more on a fully expensed basis but it will stop climate change which will save a lot of money". Our blogger has upgraded it to include "lower energy costs".

[Blissex]

«There’s also a case for nationalizing utilities and oil companies so that their rents are socialized and could be recycled back to us. This would prevent the growth-depressing transfer of real resources»

Here our blogger is advocating the nationalisation by the UK government of the ownership of the arab, iranian, texan, nigerian, russian, venezuelan, norwegian oil companies, because otherwise lots of real resources will continue to be transferred abroad with every import of fuels. Also the UK government should nationalise Électricité de France to which this country transfers a lot of resources to pay for electricity imports. It used to be called colonialism, but I guess that now it can be renamed "anti inflationary foreign strategy".
England Rules The Waves! :-)

https://www.statista.com/statistics/381963/crude-oil-and-natural-gas-import-origin-countries-to-united-kingdom-uk/

https://blissex.files.wordpress.com/2018/04/dataukoilextrconsexpmazama1965to2015.png

[Blissex]

«the real problem is distribution imo.»

That is also the opinion of 10-14 million voters, who believe that the incomes and wealth they so much deserve are being redistributed to shirkers and parasites because of excessive wages and miserly rents, not to speak of oppressive taxes to fund lavish welfare and public services.

[ltr]

The usual argument for decarbonisation used to be something like "while energy will cost more on a fully expensed basis...

[ What China is finding and showing is that developing "alternatives to carbon-based fuels" is significantly limiting fuel costs. This is recognized as most important for Belt and Road fuel projects as well as domestic projects. ]

[Blissex]

“There’s also a case for nationalizing utilities and oil companies so that their rents are socialized and could be recycled back to us. This would prevent the growth-depressing transfer of real resources”
«It used to be called colonialism, but I guess that now it can be renamed "anti inflationary foreign strategy".
England Rules The Waves! :-)»

Here is a poster from some decades ago that celebrated the "anti inflationary foreign strategy"of that time:

https://blissex.files.wordpress.com/2022/03/poliuktradeempireasymm.jpg

Some "unrelated" images thrown in:

https://blissex.files.wordpress.com/2022/03/poliusaafgdonateterror-198x.jpg

https://blissex.files.wordpress.com/2022/03/poliuktradebuyempiregoods.jpg

https://blissex.files.wordpress.com/2022/03/poliukrnationdefense-1919.jpg

[Blissex]

«developing "alternatives to carbon-based fuels" is significantly limiting fuel costs»

Really bad news for Arabia, Russia, Texas, Iran, Alaska, Heilongjiang, Nigeria, Norway etc., and for BP, Rosneft, Exxon, CNPC, Total, etc., but really good news for most of Europe.
Splendid opportunity for massively shorting the latter corporations.
:-)

[ltr]

«developing "alternatives to carbon-based fuels" is significantly limiting fuel costs»

Really bad news for Arabia...

[ Importantly, the prime carbon-based fuel producing states are anticipating the changing cost structure in fuel production and looking to China in developing through the change. I am struck by how economically close investment relations with China have grown for the likes of Saudi Arabia, UAE, etc. ]

[rsm]

《lots of real resources will continue to be transferred abroad with every import of fuels.》

Is money created by balance sheet operations in City finance firms really a "real resource" though?

[Staberinde]

This is why I despair at the blunt instrument of monetary policy.

Interest rate rises are just an arbitrary punishment for homeowners who haven't fixed their mortgage rates, and still need to eat, drive, and keep warm regardless of the cost. Taking money out of their pocket so they don't buy a new Dyson is just a double whammy: dirty carpets AND no impact on energy bills.

Between the demand-price-inelasticity of energy and fixed rate mortgages, I wonder what impact monetary policy can have at all on this kind of inflation. It's almost entirely exogenous in nature anyway.

[Blissex]

«This is why I despair at the blunt instrument of monetary policy. Interest rate rises are just an arbitrary punishment for homeowners who haven't fixed their mortgage rates»

I guess that the opposite of course must hold to: the BoE cutting interest rates to than 0.5% for the City and 2% for mortgage owners was instead the the bestowing of deserved rewards for the funding and voting for right-wing parties by finance and property rentiers then. ;-) or rather :-(

[Staberinde]

@Blissex

That might well be the case, but it doesn't address my point.

I'm arguing that monetary policy is a poor tool for the job when inflation is exogenous and driven by price-inelastic goods. Gas price inflation is not driven by consumer demand that needs cooling. It's not a lobster supper every other evening that could be substituted for soup and a roll.

If you want policy to transfer income or wealth away from property rentiers, by all means go at it. But be aware that while a cut in mortgage interest benefits both the homeowner and the landlord, raising interest rates is detrimental to the homeowner and the tenant. So I'm not sure monetary policy quite does the trick. A bit of legislation and fiscal experimentation might work wonders though.

It's a bit like taxing fuel to encourage EVs. It doesn't. You need to tax ICE cars and subsidise EVs so they become the obviously cheaper substitute and you collapse the ICE market. Fuel tax just means people pay more to use an asset they can't afford to switch.

Right tool for the job is my argument.

[Blissex]

«when inflation is exogenous and driven by price-inelastic goods. Gas price inflation is not driven by consumer demand that needs cooling»

Ah such charmingly innocent assumptions! Never mind what happened during the 1970s oil shock, here is an older example of how price-elastic is something like shelter and heating:

http://www.antipope.org/charlie/blog-static/2011/10/a-cultural-experiment.html#comment-214405
«the piles of emaciated corpses in the parks of London every winter during major economic recessions.»

Or alternatively about both shelter and heating today in a major city:

https://www.smithsonianmag.com/history/what-happens-when-a-homeless-new-yorker-dies-808498/
https://www.nytimes.com/2016/01/19/world/asia/delhi-sleep-economy.html
«But shelter, given Delhi’s extremes of heat and cold, is often a matter of survival. The police report collecting more than 3,000 unidentifiable bodies from the streets every year, typically men whose health broke down after years living outdoors. Winter presents especially brutal choices to homeless laborers, who have no place to protect blankets from thieves in the daytime hours. Some try to hide them in the tops of trees.»

[Blissex]

«Gas price inflation is not driven by consumer demand that needs cooling»

And here we can also about "austerity", the original and real one, beware of imitations:

* Since 2010 there has been no "austerity", as "the economy" (that of mass rentiers) has been booming, but redistribution, a rather different concept.

* In the 1970s exogenous oil shock there was real austerity: the goal was to reduce living standards and this consumption across all social classes, in order to reduce the trade deficit, and there was both a monetary and fiscal squeeze, hitting both rentiers and workers and businesses.

Because given a hard enough squeeze people use the car less, buy less stuff reducing industrial energy consumption, dial down the heating thermostat. Even if energy price inflation is due to a fall in supply rather than a surge in demand, cutting demand, however harshly and painfully, does work in matching reduced supply.

Any given level of energy consumption is not a vested human right or a constant of nature. It is driven by affordability.

[Blissex]

«Right tool for the job is my argument»

And mine is more widely that it matters what is the right job in the interests of whom. When George Osborne wrote:

“A credible fiscal plan allows you to have a looser monetary policy than would otherwise be the case. My approach is to be fiscally conservative but monetarily active.”

he was not speaking as a philosopher-king choosing “the right tool” abstractly but that the job was “hopefully we will get a little housing boom and everyone will be happy as property values go up” and “fiscally conservative but monetarily active” was the way to further the interests of his "sponsors" and voters.

[Blissex]

«It's a bit like taxing fuel»

Taxing fuel has an enormous advantage: fuel after the depleting of the scottish oilfields is both imported and has an inelastic supply in the short term, and the tax both discourages consumption and transfers rent from the foreign supplier to the national government.

«to encourage EVs. It doesn't. You need to tax ICE cars and subsidise EVs so they become the obviously cheaper substitute and you collapse the ICE market.»

If you need to subsidise EVs then they are not the cheaper substitute, *obviously*. Unless one is doing a "learning curve"/"volume pricing" strategy and is sure that will work.

«Fuel tax just means people pay more to use an asset they can't afford to switch»

They can't afford to switch only if one regards a certain mileage per year by commuting from low density micromanors in a certain class of car as vested human right.

Given suitable price incentives as in less affordable fuel most people will use more public transport, switch to microcars or mopeds, live nearer workplaces in denser housing, etc. etc. etc.; living in suburban 3 bed semis with a garden and then commuting cheaply to work in a SUV or even "just" a Corolla is not necessarily a vested human right. Oh the humanity! :-)

There is no need for highly polluting EVs, the ideal ecological solution would be everyone using something like a Honda C90 ICE moped or a modern version of an ICE Fiat 600 car, or horror of horrors take the bus/tram.

[Blissex]

«raising interest rates is detrimental to the homeowner and the tenant»

But in very different measures: rents would as a rule fall down a lot more than wages, because it is certainly not the productivity of property (which is zero) that generates the owner's profits,

The point I was making is that if lower interest rates benefit property owners a lot more than tenants, the viceversa is also usually applicable.

And that regardless of the notorious situation that there is no single "interest rate" as "aligned" Economists propagandize, but that interest rates paid by finance "friends of the BoE" are 0.5% and paid by property owners "friends of the tories" are 2-3%, but those paid by business and individual borrowers are often in the 10-300% range.