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The answer to ‘wage-price persistence’ is not higher interest rates – there are better, more democratic ideas

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James K Galbraith is Professor of Government and Chair in Government/ Business Relations at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin.

It is jarring when a secure and comfortable professor writes that others must lose jobs so that inflation can be contained. And it is even worse if he explains that ‘the only solution… is to restrain demand’ through higher interest rates – a good solution for those with cash on hand. Let me reply on the merits of Jason Furman’s recent call for this ‘solution’.

Furman says that in the US, “aside from food and energy price increases, the bulk of the inflation was originally caused by demand”. The words “aside from” are key. Over the 12 months through June 2022, energy prices are up 40% – with petrol up 60% and fuel oil up almost 100% – and food prices have risen 10%. Prices of everything else have risen just 5.9%, and one must allow that energy prices affect the price of everything else. Furman’s claim recalls the old gag: “Aside from that, Mrs Lincoln, how was the play?”

There is no evidence that demand, rather than cost, caused non-energy, non-food price increases – and there are good reasons to be sceptical. Costs are wages and raw materials plus profits; they are paid for by sales, also known as demand. Demand and cost are nearly inseparable; opposite sides of the same economic accounts.

Shifting his ground from demand to cost, Furman says “businesses will most likely continue to pass along the costs of higher wages to consumers”. He barely mentions profits. Yet profits are very high, and high profits come partly from high profit margins – or prices. Furman focuses on wage-price spiral (renamed “wage-price persistence”); he is silent on profiteering. Has he not heard of monopolies or the predatory corporation?

And what do higher interest rates have to do with “wage-price persistence”? Absolutely nothing, at least in the short run. Higher interest rates initially just enrich people and institutions (like banks or Harvard University) holding supplies of cash. For business borrowers, interest is another cost to be passed on to consumers in higher prices.

Only when the US Federal Reserve pursues truly extreme measures will prices start to fall, as happened when Fed chair Paul Volcker pushed short-term interest rates to 20% in the 1980s. But this mechanism works by slashing growth and driving up joblessness, bankruptcies, foreclosures, suicides and crime. That is what Furman urges current Fed chair Jerome Powell to do.

Read more in Daily Maverick: “One wonders what’s lurking beneath the surface of the anxieties and fears of the inflation hawks

Read more in Daily Maverick: “Outsized US Fed rate hike satisfies markets but is far from being a cure-all

But high interest rates are not “the only solution”. Jamaal Bowman, a Democrat in the House of Representatives, has proposed a bill with better ideas – democratic ideas. Bowman’s strategy is to stabilise prices by producing more, not less, while taking steps to prevent price gouging and unjust enrichment. His policies would help break “persistence” – without recession and unemployment.

Is it correct, as Furman claims, that we are in a period of “persistence”? This is a statistical illusion. As price changes are reported on a 12-month basis, any jump in a key cost, such as oil prices, will keep generating new headlines every month for a year. But persistence of headlines doesn’t mean price increases are persistent. They might not be.

The US national average gas price is down 17% from the peak in June. So, soon there will be less cost pressure on everything. Why is this? Partly, perhaps, because speculative control of US oil markets is unstable. The great inflation scare may be over.

The future is uncertain, of course. But we have just seen two quarters of falling GDP, well ahead of Fed forecasts. Last year the Fed predicted 4% real growth in 2022. It is thus bizarre to argue that the Fed should keep ramping up interest rates to fight an energy price shock that is fading away. The fact that the argument plays well to the monied classes doesn’t make it smart, or wise, or good. DM168/www.project-syndicate.org

This story first appeared in our weekly Daily Maverick 168 newspaper, which is available countrywide for R25.

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  • Rod H MacLeod says:

    Interesting thoughts. But let’s face it, Fed interest rate policy has more to do with Dollar hegemony and the exchange rate than domestic economic policy. Also, when you mentioned “Bowman’s strategy is to stabilise prices by producing more, not less, while taking steps to prevent price gouging and unjust enrichment” you fail to point out that Bowman has no recommendations on how to improve productivity in the face of labour unrest, nor does he explain what he means, precisely, by “profiteering” – does that include windfall profits? – nor “unjust enrichment”. That is why people remain highly sceptical of “democratic” economic solutions. Turkeys don’t vote for Christmas.

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