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Is it time yet for a reality check?

file photo: italian government is due to announce stricter coronavirus disease (covid 19) restrictions
A man shops groceries at an open-air market in Italy
In a mad world there are signs that the evident results of wayward economic policy may change the political weather

By Andrew Shouler

Unintended or not, the consequences of mistaken economic policymaking have returned to haunt us, no longer insidious but suddenly apparent to all. Inflation is back with a vengeance, hitting 7% in the US, 5% in the EU, 5.4% in the UK — numbers not seen for a generation. Excess demand, fuelled by monetary and fiscal largesse alongside recovery from the pandemic, with supply chain disruptions and other inflexibilities, has produced the inevitable.

What was not so inevitable was an energy crisis rooted in not only that economic mismatch but also the political fervour for a green agenda imposing substantial short-term costs before it can feasibly bring long-term benefits. The global fossil fuel sector is still vital, and can now inflict heavy wholesale costs, forcing price spikes that turn into trends when tolerated by central banks.

We have hereby reached the crossroads plainly signposted on the dusty maps available. Governments must now decide how to try to restrain inflation without the economy imploding. It may actually be impossible, stagflation (inflation and stagnation) being the unavoidable product of past practice, baked in the cake. A rude awakening is once again in the offing, another iteration of the very expensive ‘free lunch’, paid subtly by some for an interim but eventually, calamitously by most.

It is the latest example of a litany of policy disasters through history, wherein confident plans are unfortunately not derailed by those who perceive the pitfalls in advance (dismissed as Cassandras), but eventually by the baleful corollary of the schemes themselves, especially if on a grandiose scale. Those political commitments are mugged by reality, unsustainable by wishful thinking alone.

Right now the impact on living standards heralds a febrile atmosphere, distinctly unwelcome in the wake of the Covid experience. Yet the threat of surging inflation has been plain for quite a while, given the systemic leaning of central banks towards it, and their intensification of that bias in the past two years, effectively funding a massive budgetary blow-out.

They have taken the conventional view that controlling inflation is not as important as stimulating growth, that growth is stimulated by expansionist policy mandated by government, and that in fact inflation cannot establish itself if unemployment exists still to any degree. Superficially attractive to some, this is a line of argument familiar to students of 20th century economics, which became utterly undone in the 1970s, following the oil shocks especially.

Yet it was revived — these days enhanced further with policies seeking to enforce social obligations as well, on matters of corporate governance, climate change, and employment diversity. Restricting inflation became very much relegated in official minds, even potentially embraced again as the way to alleviate the massive debts induced by the interest rate policy itself.

The destructive circularity of that magical thinking should be obvious. Unfortunately, it has been advanced by statistical models detached from the real world. Theories producing defective inputs will produce defective outputs, dangerous when converted to policy implementation. As they say in such circles: garbage in, garbage out. Nobody has to think very hard to realize it is not the only domain in which that observation relates today. The point is to consider what lies behind those misapplications of data, what are the motivations, and how do they pertain to issues of administrative competence and democratic will.

Sticking to the economy, those who have encouraged the idea of higher inflation helpfully oiling the wheels of activity have recently been backtracking upon the clear evidence of households being pummelled by their loss of purchasing power. Some, though, even claim thereupon that the economic damage itself is a further reason not to raise interest rates. The phrase ‘you cannot make this stuff up’ is irresistible at this sort of juncture, with an end-game (reductio ad absurdum) of roaring inflation and unmanageably mountainous debt firmly in the frame. Damage is heaped upon damage in that cycle, growth decimated by inflation itself.

If those notions seem overblown, don’t take my word for it. While the US Federal Reserve, having pumped billions and billions of dollar liquidity into the world economy, belatedly considers reversing course — tough in the elephant trap it has resolutely dug — a staff paper it has published argues that a lot of what it takes for granted is baloney. Read that again. An in-house economist in its own ranks stated last year that “mainstream economics is replete with ideas that … are arrant nonsense”, though generally accepted. It is a staggering admission, but a very credible one when you view where we are now and how we got here.

Only it was known fifty years ago. Of course, the Covid hiatus imparted a severe jolt, but why would authorities continue to emphasize stimulus when trendlines of economic growth have been restored? Did they really believe in the Magic Money Tree (or Modern Monetary Theory as it is otherwise known): that governments can keep printing money and accommodating debt to spur spending with interest rates low — when in fact those rates are low by diktat (official benchmarks) and state-sponsored financial repression (compressing bond yields)?

Indeed, it is only a few months since some commentators excitedly hailed so-called Bidenomics in the US (essentially spend-borrow-print-tax-spend, on steroids) as some kind of revelatory scientific breakthrough, rather than (now exposed) as proof that there is nothing new under the sun, that it isn’t different this time, that those who don’t learn from history are doomed to repeat it, and that you can fool some of the people some of the time.

So how did this happen, and will we (or they) ever learn? Well, it would seem, once again, that the answer to that question rests among the minority of dissenters rather than the established, majority consensus and its remarkably dogged groupthink.

In the 1990s the Western economies experienced what was known as the Great Moderation. Economic growth spurted and inflation was restrained by globalization, in trade and competition, albeit imperfectly. Central banks were content to claim the credit, without obviously having done anything but rest on the laurels of previous disinflationary efforts, notably the uncompromising (Fed chief) Volcker squeeze in the US and the restrictive Maastricht criteria required for euro membership in Europe.

Twenty years ago, however, presaging the Global Financial Crisis, the key tenets associated with that moderation, namely steadiness in monetary and fiscal policy settings, were broken, and a divergent policy path chosen. Critically, the so-called Taylor rule, a neutral stance which had more or less guided interest rates between inflation and growth concerns, was dropped in favour of lower rates, and lower still, a very graphic deviation that would become noticeably habitual.

That choice, adopted internationally — and actually seeking to promote inflation where it didn’t exist — was then reinforced by the cash creation process called ‘quantitative easing’, in the jargon. The product of those machinations was all too predictable when they translated into monetary impetus. (Stanford professor Taylor himself deduced that strategy had been politicised, towards interventionism. Well, yes, that would explain it.)

Even now the central banks still talk of inflation being driven by ‘expectations’, when in fact it is driven fundamentally by liquidity, financing excess demand over available supply. If you turn the taps powerfully on in a bath-tub while the plug is in, the outcome is not in doubt, a matter of reality, not of imagination and painstaking deconstruction and justification. Sometimes basic awareness outperforms over-education; common sense trumps self-indulgent, fantastical erudition.

Ultimately, diversity of opinion and its platforming is critical for the unveiling of (especially social) scientific understanding, its discovery and even evolution. Some like to speak of facts, as if unchanging, set in stone. (Ironically they tend to say the facts have changed when they are proven wrong and declare it the basis for changing their mind.) But there are often countervailing facts that need declaration. And facts of context. Facts proclaimed in isolation can still be propaganda.

Thus, there is truth, and there is the whole truth, some of which in science is unknown if not unknowable. Assessing it requires trial, error, eventual proof or otherwise, and ongoing scepticism for the distillation of broader wisdom and due policy. In the meantime, scenarios are assigned probabilities, and forecasts selected by discretion, often in the relative dark. In the economics field, at least, proof of theoretical and policy failure is as close to being delivered as can be. Reality beckons, the reckoning yet to be told.

Bottom line, from a detached perspective, is that it is a fascinating era, the like of which modern generations can hardly fathom, with its serial manifestations of make-believe in society, for which few voted or ever would. Economics is not the only prominent area of research to have been in thrall to dodgy modelling and misdirection. A friend of mine tells me he wakes each morning into a state of disbelief at the state of the world and what is being done, and has continually to adjust. Frankly, no wonder.

  • Andrew Shouler is a freelance writer and former banking economist

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