As central bankers from around the world converge at Wyoming for their annual Jackson Hole conference in August, the question that struck me is should it be their responsibility alone to fight consumer price inflation that is raging across many parts of the world.
Of course, a lot depends on what kind of inflation it is and what is causing it. These tend to vary from country to country and a nuanced approach is required. This year, central bankers, bankers and economists as well as multilateral financial institutions are meeting to discuss structural shifts in the global economy, from what the Kansas City Federal Reserve – hosts of the Jackson Hole Summit – website says. I am curious to know what these structural shifts are, as what the world is coping with at the moment are cyclical issues around economic recovery from the pandemic and then, the post-pandemic effects which are fuelling inflation.
Speaking of consumer price inflation specifically, these were initially fuelled by supply shortages of certain commodities and goods such as semiconductors. And while the type and kind of inflation are different across economies, the common cause affecting most economies at the end of 2021 and well into 2022 were supply chain related issues. As I have written before on my blog, generous stimulus measures such as unemployment benefits and stimulus cheques to households in America and job protection programmes and furloughs in UK and Europe were also responsible for inflation in these western economies, as they kept consumer demand – especially pent-up demand – high, even as unemployment levels were coming down.
And as I wrote in my previous blog post, CPI is now trending down in most of these countries, albeit at different speeds, in response to central banks tightening monetary policy and raising interest rates. It is around 4% in the US, between 5% and 6% in the Eurozone and has only just ticked below 7% in the UK. Most of the inflation now is on account of food, beverages, alcohol and tobacco, which indicates that consumer demand for staples is still holding up, while energy price pressures have eased. Remember, the latter were the main cause of worry as Russia attacked Ukraine in February 2022, prompting many governments to subsidise energy costs for households. Services prices, mainly travel-related, are still at elevated levels since travel seems to have recovered strongly.
However, a new cause of concern seems to have crept in, and that is to do with higher wage pressures. While earlier only the UK was showing strong wage increases, now these are being felt even in the US and in Eurozone countries. Some of the wage increases suggest a tighter labour market as unemployment ticks down and labour participation rates improve. And while central banks’ raising interest rates ought to create a slight weakening of labour markets bringing down the wage pressures as well, there is the problem of core inflation staying high as higher fuel and energy prices have already filtered their way into prices of most goods and services reflected in more generalized inflation now and for some time to come.
If we look at major economies in the east, such as India, China and Japan, the situation is quite different and peculiar to each country. Japan is still experiencing high CPI, though mostly on account of the weakening of the yen, making imports more expensive for Japanese consumers. Japan’s Q2 2023 GDP, however, came in at a strong annualized rate of 6%, driven by strong exports especially of automobiles. Domestic consumer demand is weak, which is cause for concern. In India, the latest CPI reading spiked on account of higher food price inflation, thanks to the erratic monsoon and extreme weather we have had. Core inflation is also still at elevated levels and the RBI has maintained a hawkish stance even while keeping interest rates unchanged.
China on the other hand is exhibiting strange signs of an economic slowdown, which seems to be worse than earlier thought. Almost all economic indicators from industrial production and trade, to PMI and retail sales suggest a deeper slowdown. Some of it is inexplicable, as China is one country where CPI has been low and reasonable, and the country has only now gone into deflationary territory. The housing and real estate sector in China has been in the doldrums and as I wrote in my previous post, China’s crackdown on private sector companies, especially in the tech industry, might have dampened investor sentiment. But nothing explains the fall in consumer demand, after the zero-Covid lockdowns were relaxed.
All of this, especially the higher wage pressures in western economies and the serious slowdown in China, brings me to the issue of whether fiscal policy doesn’t have a role to play in controlling consumer price inflation. UK is one country that has actually raised taxes on corporations to 25%, since the government was faced with a huge fiscal hole after all the spending during the pandemic. Taxes on individuals and households were also increased indirectly through measures like the national insurance contribution, even while households were cushioned against rising energy prices in 2022. Now, as wage pressures are still the highest in the UK making it harder for the BOE to combat inflation, perhaps it’s a good idea to consider other fiscal measures.
In the US, while the Biden regime did push for increasing taxes on the wealthy in order to fund their huge infrastructure and spending plan, they were not able to get it through Congress. According to the CBO’s analysis of the budget for 2023 the US fiscal deficit – already at 5.8% of GDP – will reduce to around 5% by 2027 and then rise to as much as 10% by 2053. This is assuming that Trump-era tax cuts will expire in 2025 and tax rates will automatically increase. Besides, the government’s negotiating position on raising taxes was further weakened by the debt ceiling discussions with the Republicans. If, as some experts like Robert Kaplan said on CNBC news, Biden’s big spending plans increase consumption demand in the months and years ahead, inflation is likely to remain on the higher side. And I think that if wage pressures continue, the next US government will have to consider tax increases as well.
In Europe, especially the Eurozone area, CPI has been coming down though the latest reading shows that the CPI in some central and east-European countries is still higher than others. ECB chief, Christine Lagarde has been calling for governments to withdraw fiscal support measures, including those that protected households from rising energy prices, in order to lower inflation.
In India, we don’t see the immediate need for fiscal policy changes on the tax front and in any case, they are unlikely in a pre-election year. In a recent programme on CNBC TV18 just ahead of RBI’s policy decision on August 10, 2023, Pronab Sen, former chief statistician government of India as well as former member, Indian Planning Commission, remarked at the government spending being unusually low during the first quarter of FY24, adding that the government was probably saving it for the last quarter before the elections in 2024.
I was also wondering if China ought not to be considering tax concessions for certain income segments, in order to boost consumption and stoke inflation a little. They have cut interest rates once again, but I wonder how much that alone will do to increase domestic consumption demand. There are reports of the Chinese government planning to introduce measures to boost consumption of discretionary goods by households, but they all seem to be focused on home-improvement! I think it might be better to look at which segments of Chinese consumers are cutting back on spending and introduce tax breaks accordingly that might boost consumption. On the other hand, a major upward pay revision for their government civil servants might have a large and significant impact on consumption and inflation, as it does in India.
What I mean to say is that it is time governments also considered fiscal policy measures along with monetary policy. If inflation continues to go down, but wage increases remain sticky, and real wages actually increase at some point, it might make sense to consider income tax increases, however politically unpalatable they might be. Besides, through the years of accommodative monetary policy plenty of easy money has also found its way into equities and other asset classes, adding to the wealth of investing classes. This too has fuelled consumption demand, and it might be worthwhile considering capital gains tax increases as well. This would be especially warranted in economies where inequalities of income and wealth have grown during the pandemic and post-pandemic years.
Returning to the structural shifts in the global economy theme of this year’s Jackson Hole Conference, I can see a few. Most importantly, these are structural shifts taking place as a result of geopolitics, led by the US tangling with China, as also the war in Ukraine. The former, in my view, is pushing China and Russia ever closer together and that makes it a terrible move for yet another reason. There are also global geo-political realignments that we can expect as a result of this.
Then, there is the structural shift from global supply chain diversification that is already under way. This by itself would have been alright and orderly; coupled with the US eco-tech competition with China, it can become terribly disruptive and even jeopardise economic growth in the entire south-east and east Asia region. Remember, China and emerging economies in Asia are the growth engines contributing to almost half of global economic growth.
The third and more enduring structural shift is the demographic changes that nearly all developed countries are seeing, making it imperative that they plan for reforming their tax systems, social spending as well as for ways to boost economic growth.
And finally, we have the structural shifts emerging from our responses to climate change. Whether it is the shift to renewables, diversifying away from Russian oil and gas, electrification of transport and carbon emission reduction policies, all countries around the world have their policy commitments to follow through on. As I have written recently on my blog, climate change policies also need to urgently address farming and the lives of the poor.
None of these shifts directly affect central banks, though, since they are not connected with monetary policy alone. Besides, central banks have too much on their plates already! The US Federal Reserve Governor, Jerome Powell, in his keynote address at the Jackson Hole Symposium spoke of the need to stay focused on controlling inflation as it trends down as well as the outlook keeping in mind the US labour market and economic growth. As far as the structural shifts are concerned, there are some papers presented on the impact of monetary policy on long-term growth, though its effect on innovation and the like, which you might like to read here. Nothing that struck me as particularly structural or global, I have to say. How supply shocks emerging from the energy transition as well as fragmentation of global trade and supply chains could impact inflation for a while longer was discussed, and the ECB chief, Christine Lagarde, spoke about it as well. Globalisation under threat was also on the summit agenda, and you can read about those as well through the link to the summit page.
However, that still begs the question if monetary policy alone is meant to be a magic wand controlling inflation, or if fiscal policy ought to complement the fight against inflation – or in boosting consumption – as the case may be. I think the time for fiscal policy to play its role is coming soon, even though three major economies, US, UK and India go into elections next year.
The animated owl gif that forms the featured image and title of the Owleye column is by animatedimages.org and I am thankful to them.
Peripatetic Perch 