MONETARY POLICY AND STAGFLATION

Monetary policy reacts helplessly to stagflation

By Robert Kurz

[This article published in: Freitag, 4/11/2008 is translated from the German on the World Wide Web, www.exit-online.org/druck.php.]

The game is not over yet. In the post-game time of the global deficit economy, German labor minister Scholz again hopes for full employment with the glorious Hartz reforms (German welfare reform combining income support and unemployment benefits and drastically reducing the duration of benefits). In reality, financial bubbles and indebtedness orgies fed the growth of the last years. Now the bill comes in the form of worldwide inflation. 50 countries already have double-digit rates; 42 percent of the world population is affected. The central banks of Sweden, Norway, India and Mexico recently reacted with higher interests. In the euro zone, inflation in June 2008 was 4 percent, twice as high as the target of monetary policy. The European Central Bank raised its key interest rate 25 base points from 4 to 4.25 per cent. Thus the real interest is barely above the inflation rate. In the US, the real interest is far below the inflation rate after the excessive interest reductions in the course of the financial crisis.

On both sides of the Atlantic and the Pacific, interest policy is caught in a dilemma. Opening the money valves in the US where the worldwide inflationary process was launched should cushion the swelling financial crisis although only the balance sheets of the banks were rehabilitated. Conversely high interests of the US Federal Reserve will check the credit growth and force the ramifications of the financial crisis on the economy. To really control the inflation, central banks must raise the key interest more strongly. This will ultimately drive the real economy to the abyss. Monetary policy only reacts helplessly to stagflation. Since the interest differential between the US and Europe has reversed, the euro rises constantly and with the oil price gradually strangles the export economy while the US deficits in foreign trade with China cannot be financed any more. Simultaneously contradictions break out in the euro zone. Italy, Spain and France are up in arms against the half-hearted interest hike of the European Central Bank (EZB) because their economies have collapsed more intensely than the German economy.

The unions also criticize the European Central Bank on account of the interest-measures dampening the economy. But at the same time they fear the inflationary pressure in the coming wage negotiations that could force them to a hard course. The state can no longer be the economic locomotive. The tax revenues in the years of the deficit economy bubbled while the savings rage reduces investments in the educational system. Only the losses of the banks were socialized to avoid the collapse of the financial markets. Finance minister Steinbruck holds fast to the goal of a balanced budget. State finances should be rock-solid in the downswing. Although neoliberalism declares bankruptcy, Keynesianism cannot be welcomed any more since state “deficit spending” would drive inflation.

The game will soon be over, said William White, chief economist of the Bank for International Settlements (BIZ) about the “excess” financial bubble economy. Unfortunately only growth with precarious job effects in Asia or in German mechanical engineering occurred through this “excess” while mass poverty was already advancing. When the corrupt magician is gone, the illusion policy will also end. The choice between inflation and recession does not exist any more since the world economy will probably suffer both. So goes capitalism when it no longer functions. But all this is mere psychology, the Institute of the German Economy says. The central bank must check long-term inflation expectations so the wage-price spiral will not occur in “second-round effects.” When consumers finally spend the money they don’t have any more, everything will be just fine.