Increasing revenues and decreasing labour power. Who actually benefits from inflation targeting?

 Increasing revenues and decreasing labour power. Who actually benefits from inflation targeting?

This inflationary time has served as a helpful reminder.

It has brought to our attention the fact that Australia's economic institutions have been employing a certain framework for policy-setting for the past 30 years.

And it has a bias against workers.

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Since 1993, the government has made an effort to keep inflation under control by limiting pay increases to "acceptable" levels while allowing businesses to make as much money as they can.

And this outbreak of inflation is making that very evident.

Australian workers have been reprimanded during the past year for wanting salary rises that matched or exceeded inflation, but firms have evaded criticism for amassing extraordinary profits, despite the fact that their profit-taking has been contributing to this inflation's worsening.

This is one of the arguments made in a new report that was just published today, which asks policymakers to look at the true causes of current inflation.

Pandemic price increases

The paper, "Inflation: A Primer," is 70 pages long.

Greg Jericho, a policy director at the Australia Institute, a left-leaning think tank, wrote it. The Australia Institute is home to the research centre Center for Future Work.

The essence of the paper lies in the second part, which follows an explanation of inflation's fundamentals in the first.

Mr. Jericho reminds us that this year's spike in inflation surprised economists.

According to the IMF's World Economic Outlook published in October 2021, OECD countries' annual inflation rates were expected to vary just slightly in 2022. But after six months, such projections were completely outdated.

Check out his graph below. It contrasts current inflation rates with the IMF's forecasts.

A similar argument was made by Philip Lowe, the governor of Australia's Reserve Bank, in a speech delivered in Sydney last month.

Inflation could end this year at 7.75 percent or more, he added, compared to the RBA's previous prediction of 1.75 percent inflation until 2022.

Dr. Lowe acknowledged, "This is a pretty huge change and a very big predicted miss."

He emphasised that while this inflation had caught everyone by surprise, it was not an excuse.

Forecast misses of this magnitude ought to cause forecasters to reflect, and the RBA has done just that, he added.

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"It is crucial that we take this information to heart and deepen our comprehension of the inflation process."

Although that was a wonderful display of humility, there were clear issues with it.

Central banks ought to be better knowledgeable about the phenomenon they have been formally "targeting" for 30 years.

What else do they not know if they have such limited knowledge of the inflationary process?

If they don't fully comprehend the inflation process, why should we believe them when they say that delivering low and stable inflation is the best way for central banks to advance our common welfare?

It also doesn't seem like it should matter how low inflation is. How are workers benefited if inflation is kept low by keeping hundreds of thousands of people unemployed needlessly?

As Mr. Jericho notes, Australia did experience relatively low and stable inflation in the five years preceding the epidemic.

However, during those years, unemployment and underemployment rates were higher than they had been prior to the Great Recession, and real household discretionary income had stagnated to a degree that had not been seen in 60 years outside of a recession.

He writes, "It was plainly disproven that low and stable inflation would automatically usher in economic wellbeing."

Where is the recent inflation manifesting itself?

Let's take a short look at how local prices have performed this year, though.

Rising inflation really started to take grip in the first half of 2022.

Prices increased by more than 1.5% for two consecutive quarters for the first time since 1990. (2.1 per cent in the March quarter, and 1.8 per cent in the June quarter).

The most significant price rises were observed in automobile fuel (due to world events), veggies (due to the floods in NSW and QLD), and new home sales (due to the unprecedented surge in property prices sparked by ultra-low interest rates and speculative pressures).

You get a different image of the overall increase in inflation when you take into consideration how products are weighted differently in the consumer price index (CPI) basket.

For instance, new homes have a significantly higher weighting in the CPI basket than do vegetables or gasoline for cars.

The rise in new home prices in the first half of 2022 was actually responsible for 1.27 percentage points of the 3.9% rise in the CPI overall.

That doesn't change the fact that "non-discretionary" items, which are those that individuals can't easily avoid purchasing, have seen the majority of the highest price hikes.

Automobile fuel, medical care, produce, rent, and utility costs are some examples.

Fast price increases for these commodities have a far greater impact on low-income households since they spend a larger proportion of their income on non-discretionary items.

Gains and inflation

How ought we to respond to this inflation?

Here, Mr. Jericho delves into the specifics of how inflation enters the economy and doesn't duck the issue of market power.

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According to a widely held but tired cliche, inflation is brought on by too much money chasing too few things, the author claims.

"However, that raises the question of whether total consumer spending is actually excessive (i.e., the economy is booming) or whether the supply of goods and services has fallen or has become more expensive to create (ie. there are supply constraints).

As an alternative, the question of whether businesses are abusing the situation by raising prices above what is necessary in order to boost their profits must also be considered.

According to the June national accounts, he claims that earnings increased by 28.5% over the previous 12 months, compared to a 6.8% increase in overall wages.

Real unit labour costs decreased by 6.4% during the same time period, but real unit profits—the amount of profits made per unit of output—rose by 13.1%.

Even after removing the mining industry, non-mining profit growth increased by 9.4%, above both inflation and wage increases.

Mr. Jericho spends a lot of time describing how issues with international supply chains, border limitations, and the effects of pandemic stimulus measures have all influenced inflation.

However, he notes that there is "clear evidence" that earnings are rising far more quickly than both labour expenses and general inflation.

According to this, businesses' willingness and ability to raise prices above what can be "explained" by increases in labour or other input costs is the main cause of inflation.

He claims that despite low unemployment rates and moderate employment growth, it is obvious that wage growth is not driving the demand-driven portion of inflation.

The consumer price index has now surpassed the wage price index for eight straight quarters (the longest such streak ever), yet wages growth is still below inflation, according to him.

"Real earnings have therefore fallen by 5.3% during this time span.

In contrast to a significant decline in living standards, especially for lower-income households who spend more on necessities, the rising rate of inflation has been accompanied by record levels of profits.

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The report provides far more information (and graphs) than I can fit here, so it's worth reading.

In a rarely explored manner, Mr. Jericho places this inflation in its institutional context.

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Although it is obvious that some of this "success" reflects circumstances that had no direct relationship to monetary policy, he claims that Australia's inflation targeting regime, which has been in existence since 1993, has contributed to a certain degree of price stability (such as falling unit labour costs and growing low-cost imports from China).

But because productivity growth has outpaced real pay growth over the past 30 years, there has also been a decline in the share of the national income that goes to workers.

He claims that although it is a frequent assumption in economic theory, the relationship between the growth of real wages and labour productivity is not always true in actual reality.

"Workers' ability to negotiate better pay depends on wage increases," he asserts.

However, since the turn of the century, there has never been a period in which productivity and inflation combined have outpaced continuous wage growth.

The grey-blue columns in the graph below have consistently been taller than the orange columns to their right (which show how workers are being compensated for their efforts at work).

He asserts that it is obvious that the decline in worker power that has resulted from inflation targeting.

"Australian inflation targeting since 1993 has not been neutral," he claims.

"During that time when inflation was being targeted, notably from 2014 to 2020, there was a significant transfer of income and economic power from workers to firms.

"The goal of monetary policy has not been to maximise the general welfare of the public through technical means.

According to him, "it obviously represented and still reflects value judgments and priorities put on how the costs and benefits of inflation management are dispersed across society."

He adds that these broad political-economic aspects of monetary policy "must be properly studied" when the federal government reviews the Reserve Bank's mandate and activities.

Sources:-https://www.abc.net.au/news/2022-10-23/growing-profits-and-less-power-for-workers-inflation-targeting/101565352