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Why wage-price spirals promote inflation – and neither Keynes nor Monetarists are completely right

The Prime Minister has raised the specter of the wage-price spiral as a way to justify the government’s opposition to wage increases for strikers. For conservatives of a particular vintage, this is a helpful bogeyman: no one wants to negotiate between the government and the unions for 1970s wage and price controls, especially when it involves bargaining with Mick Lynch.

Nonetheless, the wage-price spiraling bloody shirt waving has received criticism from economists and deserves further analysis.

The wage-price spiral refers to rising prices, which leads to workers demanding higher wages, which further increases prices and causes workers to demand higher wages. In a tight labor market with stagnant growth like ours, we can ensure that inflationary expectations are baked into the foreseeable future.

The pressure to avoid such an outcome forced the governments of Heath, Wilson and Callaghan into a variety of wage and price agreements – all of which eventually collapsed when inflation turned upward and the ‘winter of disgust’.

The government obviously wants to avoid such an outcome – especially as it opposes Thatcherite backbenchers. But not everyone agrees that a return to wage demand worsens our inflation problem.

On the one hand, you have a left-wing view, as revealed by figures like tax writer Richard Murphy. On Twitter this week, he said inflation “fails to plan for resumption from Kovid, the profitability of energy companies … war, sanctions, the lack of real food” and three big goals of left-handed anger: Brexit, climate change and bankers.

Murphy suggests that inflation is not related to wage increases, but he argues that it is safer for the government to pay for those currently striking more. Such an argument is a very useful get-out clause for the Left. This allowed the Wilson and Callaghan governments to classify inflation by signing trade unions to ever-growing wage settlements.

Yet pinning inflation on the imbalance between supply and demand is not fully in line with what led to inflation in the 1970s or today. To explain why, I need to assign a term familiar to anyone who has seen the era of strikes and Kate Bush for the first time: monetary, economical theory that prioritizes the role of governments in regulating the amount of money in circulation. The roots of inflation.

For example, governments around the Western world are facing a similar situation today after the 1973 OPEC oil embargo. As leading monetary expert Tim Congdon highlighted, the UK saw consumer prices rise by 9.2 per cent in 1973, 16 per cent in 1974 and 24.2 per cent in 1975.

But, as Congdon also pointed out, while West Germany was facing the same inflationary pressure from Britain as oil prices, consumer prices rose seven percent, seven percent and 5.9 percent each year.

Why? Due to the nominal attractiveness of monetaryism: variations in monetary policy and the rate of increase in money supply.

In West Germany, economists, fearing a repeat of the Weimar-style hyperinflation, clung to the view that inflation is a product of the growth rate in the money supply. In contrast, the overwhelming Keynesian consensus in Britain is that inflation is believed to be the product of short-term fluctuations in the relationship between supply and demand, managed by spending cuts or increases, and kept under control by wage and price controls.

In the late 1970s, the economic Gಟರ್‌tterdamerung temporarily put to rest that theory, and the victory of monetaryists has led to the relatively low inflation rates we have seen for the past 40 years.

In his post, Murphy noted that since the introduction of quantitative easing since 2009, the lack of inflation has been denied. Doing so ignores the sharp rise in property prices since then – not included in many inflation calculations – and in the first year of the epidemic, the Bank of England increased the money supply More than all the previous eleven years combined.

In addition, former Bank of England governor Mervyn King said that since 2009, QEU has been able to support government financing, but over the past two years £ 500 billion or more has gone directly to the wider economy through furlough schemes. And other measures.

As a result, the pace of money in the UK – a reflection of the desired holdings of money versus income – remained steady in the 2010s, as it plunged the Covid economy into a crisis that fell by 2020. All this monetary expansion is now full of inflation.

This does not mean, however, that Murphy is entirely wrong to highlight the impact of supply issues and price increases. As in the 1970s, different monetary policies, coupled with universal prices, produce different levels of inflation between countries, with varying levels of money supply today producing different inflation rates.

American inflation is faster and higher than European and Japanese inflation, as is its monetary growth – estimated percentages from June 2020 to June 2021.

The most ardent monetaryist and Murphy can agree on one thing: the rise in wages is not the source of inflation we see. In that sense, he’s right: inflation is rising even before the wage rise we saw last year.

But between February 2020 and February of this year, the median wage increased by more than 10 percent. The demands of Lynch and others reflect a situation in which private sector wage increases have nearly doubled over the past two years – and catching it is not without pain or consequences.

With the rate of unionization in the public sector more than five times that of the private sector, taxpayers will be on the receiving end of any settlements granted by nurses, teachers or other potential strikers, as Carl Williams of the Center for Policy. Studies on this site pointed out yesterday.

These require more spending to pay – and that means more debt. The Treasury wants to avoid too much – especially when it involves monetary expansion. So inflation can always and everywhere be a monetary phenomenon to credit to Milton Friedman, which may have political origins.

But more importantly, if inflation continues, today’s wage hike will bake in anticipation of tomorrow’s wage hike. Murphys – and Andrew Baillis – will tell you that inflation will go down as the world of Kovid solves post-supply-demand problems.

But with the massive expansion of the money supply and the ongoing high energy and food prices over the last two years, it is increasingly unlikely by day. Inflation will still be around for a while – and it will be more persistent if workers form the habit of chasing inflation with big wage demands.

To prevent this, the government must stand firm to face the obstacles of the Union. It should aim to support President Biden’s attempt to pump more oil into Saudi Arabia.

It should take a long, hard look at the amount it is spending: can it justify paying for the triple lock because it induces restraint on workers and growth remains anemic? We need a full spectrum response to prevent inflation from gaining lasting grip – it’s like economic cancer.

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