HOW INFLATION IS A POLICY NOWADAYS.

• Author: Croitoru, Lucian

1. Introduction

   The increase in interest rates entails high costs for those in debt. Inflation entails costs for everyone. How could an economist explain to someone in debt that central banks have to raise interest rates and it is not they, at least not always, that should be resented for that? To be honest, I don't think there exists a sufficiently eloquent and, therefore, embraced by people economic explanation in this case. The economic rationale is not readily accessible and, especially, it is not 'wired' to people's day-to-day life. It always involves a longer-term perspective that engages people's patience and goodwill, which have been every so often entreated and which, in most instances, have not been properly rewarded.

   In this paper, I have opted for an analysis that places people straight at the core of explanations. In order to depict the ugliness of very high inflation, in the following section I quote Hemingway, a famous writer, then I turn to Mises, a famous economist, to show why inflation, despite its ugliness, can become a way of living depending on the ideas that most of us have. Section third shows what changes occurred in the Western societies after the Second World War and how the new features can combine, depending on the ideas prevailing in the society, to fuel inflation or not. Section fourth describes three necessary measures that have to work jointly to curb high inflation. The final section shows why countries with a relatively high share of taxes in GDP could have difficulties in taming inflation and why, in the case of Romania, increasing the tax-to-GDP ratio to the average EU level would be counterproductive. Data used in the paper come from works listed in the references section and from AMECO.

2. Inflation, our preferences and German cakes

   The argument should paint a picture from people's day-to-day perspective. Economists can do that if they strive, but a writer accustomed to perceiving human micro-universes would probably fare much better. For instance, Ernest Hemingway was inspired when depicting the idea also shared by economists, namely that inflation is an adjustment in the rate of exchange between money and goods and that any drastic adjustment has favorable effects for some and dreadful for others. In September 1922, Hemingway traveled with his wife from Strasbourg (France) to Kehl (Germany). He crossed the four-kilometer bridge connecting the two towns and exchanged 10 francs (i.e., less than one Canadian dollar) for 670 German marks. This amount lasted them a day of 'heavy spending'; and they still had 120 marks left (Hemingway, 1922).

   For example, a five-course lunch at the restaurant of the hotel in Kehl cost 15 cents, while in Strasbourg it was worth 1 dollar. Hence, 'this miracle of exchange makes a swinish spectacle where the youth of the town of Strasbourg crowd into the German pastry shop to eat themselves sick and gorge on fluffy, cream-filled slices of German cake at five marks the slice. The contents of a pastry shop are swept clear in half an hour'.

   Do you think the proprietor of the pastry shop was glad to sell his goods so quickly? No, he wasn't! 'The proprietor and his helper were surly and didn't seem particularly happy when all the cakes were sold. The mark was falling faster than they could bake'. As we know, the 1922 inflation gained momentum for another year. In September 1922, 1 dollar was worth 800 marks (Hemingway, 1922), while in November 1923, the dollar was pegged at 4.2 trillion marks (Mises, 2006 [1979], p. 63). In other words, the mark was no longer worth anything. Many lessons can be derived from this short account: that inflation can spike out of control; that warfare always has disastrous implications for inflation, as is the case nowadays due to Russia's invasion of Ukraine; that very high inflation results in the destruction of the currency and therefore is not sustainable; that inflation is good for some, but bad for others, etc.

   One might say that, in the meantime, we have created mechanisms to make sure we no longer end up in a situation like that of Germany back then. I have referred to Germany, but the Austrian krone or the Russian ruble were undergoing the same process of massive loss in value at the time.

   Granted, the mechanisms in place nowadays render unlikely a currency depreciation relative to goods of a similar magnitude to that seen in the aftermath of World War I, amid the collapse of some empires. Yet there are different degrees of evil, it does not necessarily take a debacle for pain to emerge. It is enough for inflation to stick to relatively high readings over a longer period for it to lower the standard of living for most people.

   Ludwig von Mises, a direct observer of the hyperinflation in Germany and Austria, who had advised the Austrian government to stop the monetary printing press, wondered in 1959: 'If inflation is bad and if people realize it, why has it become almost a way of life in all countries?' (Mises, 2006 [1979], p. 67). Since then, the Western world has crossed periods of relatively high inflation, such as that of the 1970s, but also periods of low and stable inflation, as was the case from 1982 through 2008. Consequently, if high inflation is bad and if a large part of the people realize it, then we can add a touch to the initial question via two other queries: 'why does high inflation keep rearing its head, sometimes over relatively long time spans?' and 'why do some frown on raising interest rates to levels that would prompt inflation to stick or return fairly quickly to relatively low levels?'.

   Mises (2006 [1979], p. 72) came up with an insightful and summarizing answer to the question he formulated: inflation can be a way of life because 'inflation is a policy--a deliberate policy of people who resort to inflation because they consider it to be a lesser evil than unemployment.' And it should be reminded that it is an unsustainable policy. In the preface to the 1953 English edition of the book 'The Theory of Money and Credit', initially published in German in 1912, Mises (2009) [1953] is very clear and states that 'the great inflations of our age are, ... to say it bluntly, government-made'. He also explains, using the context of the time in Western economies, why the government resorts to higher inflation: in order to reduce the real wages imposed by unions above the free market levels; and he is being ironic when saying that John M. Keynes taught the government how to cheat the workers through inflationary policies (Mises, 2006 [1979], p. 70).

   I believe that 'inflation is a policy' is also the answer to the question of why relatively high inflation emerges every now and then in Western democracies. And, going further, the answer to the query of why some oppose an interest rate hike becomes apparent as well: because it is at odds with the policy called inflation, at least for the promoters of that policy. For those who might be immediately prompted to conclude that, in our age, this answer would refer to independent central banks or that I am talking about an unsustainable monetary policy of the central bank, let me say that it would only be a shallow conclusion, as I am about to show. In fact, one of the purposes of this article is to show how difficult can be, in a democracy, the task of an independent central bank to lower inflation and how the long roots of high inflation can be traced back to governments.

   If relatively high inflation is a policy, then I need to firmly point out that it can only emerge in strict concordance with prevailing ideas in the society. These ideas alter, over time, certain key elements in the structure of the society, so that a policy could never be at odds with prevailing ideas and with the structure of the society that those ideas shape. Each of us contributes to this structure through our preferences regarding the countless choices we make in any area.

   In their effort to win democratic elections, the politicians and the governments they form need to discover as accurately as possible to what extent these preferences are dedicated to general objectives. We could consider there are three overarching objectives that modern governments contemplate: solidarity, economic growth, and sustainability (1). These objectives are not necessarily compatible, since the focus of preferences on economic growth and solidarity can be at odds with sustainability.

   In the modern Western world, the extent to which preferences are shifted towards sustainability relative to the other two objectives can differ from one country to another or, for a given country, over time. Anyway, since these preferences are strongly reliant on cultural, social, ideological, and political factors, they are supposedly relatively stable, although changes may occur in the long run by learning. There are countries where preferences seem to be shifted towards the sustainability objective, the same as, in other countries, the preference for sustainability is weaker.

   However, we can say that, in the Western world overall, the preferences regarding those objectives led to the fine-tuning of methods to achieve them through the transformation of the capitalist society. In the history of the past 220 years, the time span when inflation and interest rates exhibited the most stability and were comparatively lower stretched between 1873 and 1913, during which time the gold standard functioned in full compliance with the rules it was based on. I can safely say that, during that period, the liberal ideology made the preferences in countries participating in the system shift significantly towards sustainability. This explains why...