MILTON Friedman was a powerful magician. His words charmed people into thinking night was day, against the evidence of their own eyes. Friedman’s maxim that “inflation is everywhere and always a monetary phenomenon” is widely accepted by economists, even though it is quite obvious that production costs, especially energy costs, play a major role. in creating inflation.
Today, inflation is skyrocketing all over the world. Economists under the spell of Milton Friedman seek and find monetary causes. Central banks around the world conducted extremely expansionary monetary policies to combat the Great Recession that followed the 2007 global financial crisis. To the surprise of many leading economists, there was no impact inflationary. Emboldened by this experience, central banks again pumped money into a faltering economy in the era of the Covid-19 pandemic. Here again, inflation did not react. But now, after all that monetary expansion has ended, high inflation has suddenly hit. Since Friedmanians believe that inflation must have monetary causes, they are forced to think that the 15 years of monetary expansion since 2008 suddenly caused inflation to spike in 2022.
If we open our eyes to events around the world, we can find much more obvious sources for current inflation. The Covid crisis has led to the collapse of global supply chains. As global economies recovered and demand rose to pre-Covid levels, growers found it necessary to look to alternative, more expensive suppliers.
The intensification of the United States’ trade wars with China has increased production costs in both countries. Soaring energy prices in Europe due to the war in Ukraine crippled the industry and led to massive price increases. The United States, Europe and China are the three largest economies, producing more than 60% of global production. None of these factors has anything to do with money supply or interest rates.
Employment guarantee programs have been successful in many countries.
A policy lesson for Pakistan would be to give maximum priority to the development of indigenous alternatives for energy production. Not only would this thwart imported inflation, but it would also combat climate change which has had a disastrous impact in the form of floods.
We will conclude this article by discussing some simple economic theories, which continue to confuse Friedmanians. Milton Friedman’s views are based on a very simple idea of classical economics. Given a fixed quantity of goods, if we double the quantity of money in the economy, prices will also double.
Keynes observed that this was not the case during the Great Depression, when production levels were very low compared to what they might have been. He noted that pouring money into the economy would lead to increased production. If we double the goods and double the money, there will be no inflation.
The Friedmanists (monetarists) reject this basic Keynesian idea. They argue that the influx of money does not lead to an increase in production and therefore inflation will result from the increase in the money supply. Empirical experience strongly supports Keynes against Friedman. Unlike the monetarists, modern monetary theory (MMT) builds on this Keynesian idea and refines it, as we will see below.
Historical experience has shown that the expansion of the money supply by the central bank has not necessarily reached the sectors of the economy where unemployment was high. Instead, money could flow into these sectors operating at full capacity and cause inflation, contrary to Keynesian views. This phenomenon has been called “stagflation”, ie unemployment and inflation. MMT suggests that the money be targeted at unemployment, to prevent that from happening.
MMT’s main policy recommendation is a job guarantee program. The most valuable unused resource in an economy is labor. If we spend money to provide productive employment for an unemployed worker, then the increase in money will automatically be offset by the increase in production. More money combined with more production will not lead to inflation.
Employment guarantee programs have been successfully piloted in Argentina, India, Sweden, Ethiopia, China, Tunisia and many other countries. Developing an effective jobs guarantee program requires ensuring that the money created by the central bank goes to productive work, not to idle consumers who will increase demand without increasing production. Our youth are Pakistan’s most valuable resource. The most important challenge facing our decision makers is to apply MMT to provide them all with productive employment.
The author is a former member of the Monetary Policy Committee and former Vice Chancellor of the Pakistan Institute of Development Economics.
Posted in Dawn, November 12, 2022