Inflation Is Not Just A Monetary Issue

The ECB bets on buying private debt

Fernando González Urbaneja | The risk of inflation which last autumn seemed temporary, caused by a temporary rise in energy prices, has become systemic. And the longer-term and worrying consequences threaten stagflation (inflation without growth and with unemployment). Economic textbooks warn that inflation is a monetary phenomenon that can be cured with monetary policy, with restrictions in the form of interest rate rises and a reduction in the money supply. A medicine that is tried and tested but takes time and imposes costs in the short and medium term. In the current inflationary crisis, accentuated by the invasion of Ukraine, time is lacking and the costs imposed by the monetary prescription on employment and growth are too high. Monetary medicine may be unavoidable but it is not clear that it is the most urgent, nor the only remedy.

The inflationary race began in Europe and the United States in mid-2021, when in Spain (and Europe) the year-on-year rate exceeded the 2% that was (and is) the ECB’s target. Last May the CPI was 2.7% and since then it has risen every month up to 7.4% last February. The ECB now estimates that this year the CPI will exceed 5% on average and some more pessimistic analysts fear that it will reach double digits, a rate that takes us back to the 1970s.
As then, most of the responsibility for this escalation lies with an increase in costs due to the rise in oil prices, which is being passed on to the whole scheme of production costs and household spending. The same is now happening with three protagonists in the escalation: oil with its effect on fuels and transport and distribution; gas with its direct impact on industrial and private consumers; and electricity (the most critical factor) dragged down by the disproportionate increase in the price of gas. This distorts tariffs due to a structure that did not take into account extraordinary factors such as a vertical rise in gas.

Containing the effect of rising energy prices is the responsibility of all economic agents and especially of governments responsible for intensive energy taxation. The Spanish government reduced electricity taxation exceptionally a few months ago. It did so belatedly and partially, but avoided a very severe impact on final consumer prices. Now the same is happening with fuels and the fiscal response is also delayed by a caution that smacks of greed. It cannot be the treasury that benefits most from the higher cost of oil, since that initial advantage will be lost later due to the fall in consumption and a foreseeable recession.

The government should reduce fuel taxation immediately and forcefully if they want to prevent fleets from grinding to a halt and transport costs from rising. It should also decouple the spot price of gas from electricity price formation. The cost of kilowatt production does not correspond to the cost of those who use gas as a raw material. What the marginalist system was looking for is not what has been happening in recent months. It is a matter of urgency to rectify the situation. Not to do so is to blow oxygen on to the inflation fire and bring the risk of stagflation closer. Inflation is a monetary phenomenon, but not only that, there are supply-side factors that unbalance and accelerate the model.

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The Corner
The Corner has a team of on-the-ground reporters in capital cities ranging from New York to Beijing. Their stories are edited by the teams at the Spanish magazine Consejeros (for members of companies’ boards of directors) and at the stock market news site Consenso Del Mercado (market consensus). They have worked in economics and communication for over 25 years.