When the economy heats up, workers demand higher wages. Meanwhile, companies are using their pricing power to drive prices up.
In that sense, all of us – employers, employees, not to mention governments that set the rules for such conflicts – are somewhat to blame for the proliferation of higher prices.
Given the breadth of forces at play in creating inflation, Blanchard’s main point is that there are actually many potential strategies to combat inflation than most people assume: “Government can play different roles. Through fiscal policy, it can slow down the economy and eliminate overheating. It can subsidize energy costs… [and] Fund the subsidies by raising taxes on some current taxpayers, say extraordinary profit taxes.”
Of course, many governments, including Australia’s, are already doing some of this, primarily through either energy price subsidies or price caps. But they could go much further when it comes to developing innovative solutions to contain price pressure, Blanchard believes.
Overall, however, Blanchard is not optimistic that this alternative policy will happen: “Unfortunately, this requires more trust than could be hoped and just isn’t happening.”
However, Krugman comes to a more optimistic conclusion in his series of tweets, which begins with this stark metaphor: “One way to think about inflation is that it’s like a sporting event where everyone gets up to get a better view of what’s going on to get — which is collectively self-destructive.”
Plunging economies into recession to curb inflation is then “like stopping the action on the field until everyone sits down”. “It works, but at a cost,” Krugman concludes.
Much better if we could just get everyone to just sit back down: “That’s hard to achieve, but not always impossible.”
Should inflationary pressures prove to be longer than expected, there are alternative tools in the macroeconomic toolbox that could be used to rein in the rapidly rising cost of living.
Krugman cites Israel’s deflationary policies in the 1980s. In an Australian context, the most obvious example would be the ‘agreement’ of a similar era struck between unions and employers to curb inflation.
Seen in this light – that prices in our economy arise from the balance of power between what consumers are willing to pay and what businesses can demand – there are a variety of potential solutions to our current inflationary problems.
On the consumer side, agreements between unions and employers can limit wages if they appear to be spiraling out of control (which is currently not the case in Australia).
On the corporate side, governments could develop strategies to curb corporate pricing power, particularly those dominated by a handful of powerful players.
More broadly, governments could commit to a new era of pro-competitive reforms to limit the pricing power of companies in sectors where there is a lack of competition – like energy companies, but also supermarkets, pharmacies and many others.
Of course, governments have limitations with such reforms. Monetary policy remains a sharp and ready-made tool to contain inflation.
But it is encouraging to think that there are many more alternative tools in the macroeconomic toolbox that could be used to rein in the rapidly rising cost of living should inflationary pressures prove longer-lasting than expected.
This particular macroeconomic party is just beginning.
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