Inflation and Power

Yves here. This post argues, and not from a Marxist perspective, that the US reliance on the Fed (as opposed to other means) to combat inflation via its blunt instrument of interest rates has the effect of whacking labor while typically not addressing immediate causes. Interestingly, author Alessandro Roncaglia also counters the monetarist and popular view that expanding the money supply causes inflation by explaining how money supply increases can be the result of inflation.

By Alessandro Roncaglia, Emeritus Professor of Economics at Sapienza University in Rome and a member of the Accademia Nazionale dei Lincei. He is the author of many books and articles. His Power and Inequality: A Reformist Perspective is just appearing in the INET “Studies in New Economic Thinking” book series with Cambridge University Press. Originally published at the Institute for New Economic Thinking website

There are strong interrelations between economic policy, culture, and power relations in society. This is quite evident in the restrictive monetary policies undertaken by central banks the world over when confronted with the recent inflationary outbursts.

Restrictive monetary policies are a standard answer to inflation. But they are not costless, exerting a downward pressure on output and employment. Thus, two questions arise: are they the correct answer in general? And are they, in this specific situation?

My answer is different from the mainstream one. The theoretical background pointing to restrictive monetary policies as the general answer to inflation does not have general validity, though it may hold in some specific circumstances. And, when confronted with the present inflationary episode, there are other policies we should consider first.

An old-fashioned quantitative theory of money is still often referred to (or implicitly relied on) by the media, and occasionally by professional economists, in support of the argument that price increases are caused by increases in the amount of money in circulation. But, as Kaldor once pointed out to Friedman, the causal link may go in the opposite direction: when prices increase, banks may be led to increase the money amount of their loans, thus increasing the supply of bank money. Moreover, when confronted with increasing aggregate demand, aggregate output too may increase, unless we are in a situation of full utilization of productive capacity, which is very rare – and certainly not our present condition.

But for sure there is an avenue through which restrictive monetary or fiscal policies exert downward pressure on inflation, and it is through the impact of a reduction in employment on the bargaining power of workers, hence on wage dynamics. Thus, these policies are an instrument of redistributive policies, not a class-neutral policy choice. (In this respect we can also notice that they favor the profits of banks, insurance companies, and financial institutions in general).

In sum, restrictive monetary policies should be considered with caution when confronted with output inflation. They are instead, quite often, a useful tool for countering asset inflation.

In the present situation, we are confronted with a multi-faceted inflationary outburst. The Covid pandemic first, then the war in Ukraine, ignited inflation by disrupting global supply chains, then gas and agricultural markets. Now the difficulties of navigation through the Gulf of Aden and the Red Sea increase transport costs and further disrupt supply chains.

Simplifying a complex matter, we can say that the restructuring of supply chains is certainly not favored by restrictive monetary policies. And, as far as gas and agricultural markets are concerned, there has been a clear overreaction of prices to the underlying admittedly difficult situation (with oil markets also displaying excess variability). Such an overreaction – the main element in the inflationary outburst – is mainly due to the financial markets that play a basic role in the price-determination process for these commodities. Financial markets do not behave in accordance with the efficient financial markets theory, driving prices in such a way as to reflect the underlying real situation: they are bent to overreact, driven by speculation.

It was a mistake – an enormous mistake – to accept a ‘reference price’-determination process for basic commodities led by finance, while direct (and often long-term) bargaining between companies at much lower prices inflates the companies’ profits, with selling prices for final products linked (by informal collusion if not by formal rules, as is the case for electricity) to the reference price. Countering this situation requires active anti-trust policies, a revision of some regulations, and more generally an active policy aiming at a retrenchment of finance (and the financialization of commodities in particular), whose growth as a percentage of GDP over the past few decades is the main cause of the growing instability of the world economy.

Such policies imply a wide redistribution of power in the economy and in society at large. They have no possibility of being implemented if not supported by a widespread recognition of the failures of neoliberal theories and policies, and this in turn requires turning upside down some established pillars of mainstream economic culture. We should recognize that culture and politics, in their more general meaning, have a deep influence on the formation of economic policy strategies.

Print Friendly, PDF & Email


  1. Altandmain

    The article basically indicates that the fractional reserve system of banking needs major reforms. If this is accurate, the system is worsening inflation. It is serving the needs of ordinary people very poorly, if at all, and is worsening inequality. Perhaps there should be a minimum reserve ratio that banks should hold that should be adjusted upwards during periods of high inflation so that banks are forced to hold more currency during inflation.

    The other big issue right no is that so long as there is no action taken on greedflation, inflation is only going to remain.

    Most of 2023’s inflation was caused by greedflation.

    The consequences are that money is transferred from labor to the rent seeking parts of society, which seems to be the norm in Western society.

    Effectively, this means a showdown with rich people. They want a system where the banks control the politicians and the greedflation to go unabated. One obvious solution would be to nationalize the banking system and go full public banking. Needless to say, that will also need a major showdown with private capital.

    The basic problem is the economy rewards rich rent seeking and has become a vehicle to destroy the lives of ordinary people. That’s true of not just inflation, but all parts of the economy.

    That isn’t even beginning touch Western foreign policy, such as wars abroad in a desperate bid to keep Western hegemony. The proxy war against Russia to try and Balkanize the Russians to loot their nation, along with the war in the Middle East are both looking like major strategic defeats for the West. In the short to medium term, it means higher prices.

    1. Yves Smith Post author

      Please wash your mouth out.

      We do not have a fractional reserve banking system. Banks create deposits out of thin air.

      From Quora::

      No. The U.S., as well as pretty much every other country, uses what is better described as a credit creation system.

      In a true fractional reserve system, banks collect and then lend out “hard” currency, in the way we have all learned from the old story. It is easiest to think of hard currency as coins – the bank has 100 coins; it can lend out 90, and keeps 10 on hand in reserve. The next bank collects those 90 coins; they can lend out 81, and keep 9 in reserve, etc., etc., until you end up with the same 100 coins in existence, plus 900 in bank accounts. Bank lending is limited by the amount of hard currency in existence. By extension, cash withdrawals are limited as well.

      The way banks actually operate is by creating credit on ledgers. Loans are “funded” 100% with credit; if you take out a $1000 loan with $200 in interest, your bank simply marks up your account by $1000, and holds your promissory note, nominally worth $1200, as their asset. M1 has just increased by $1000, and bank equity has (nominally) increased by $200. The loan, and the funding, are complete at this point. When you write a check that is deposited at a different bank, reserves (“hard” currency, liabilities of the central bank) are transferred from your bank’s reserve account to depositor’s bank’s reserve account, your account is marked down, and depositor’s account is marked up. This transaction is financially neutral for all parties.

      This is where you will get an argument from fractional reserve people. Since the bank ends up transferring hard currency, isn’t this just a more complicated way to describe FR banking? Well, no. The bank didn’t need to collect reserves before making the loan; reserve requirements are calculated days after the loan was made. Also, the central bank will always supply enough reserves to banks, so hard currency isn’t a limiting factor. Finally, if you picture two banks, each creating identical loans that get deposited in the other bank, no reserves will be transferred, yet $2000 has still been created. Which is pretty much what happens on a large scale every day – the amount of loans created every day is far greater than the net amount of reserves that must be transferred in settlement at the end of the day. In our credit creation system, reserves are merely settlement funds. If you dissolved the central bank/settlement agent tomorrow, banks could still operate just fine settling up among themselves, using mostly bank-created credit to do so. If things got really unbalanced, they could then settle up using other assets. No “hard currency” required for loans or transactions. The central bank is now merely a useful tool for settlement, funding government spending, and backstopping banks in crisis.

      This paper by Richard Werner explains the three theories of banking in good detail:
      852 viewsView upvotes

        1. JonnyJames

          My thoughts as well.

          I saw that from the BoE some time ago, I almost forgot- thanks for the link. It is so difficult to dispel the misinformation that seems ubiquitous in the popular mass media; Paul Krugman being a poster-boy for that sort of thing.

          At the end of the day, we are getting ripped off in many ways; the “greedflation” mentioned by Altanmain is only one. The oligopoly/monopoly market abuses are getting more and more obvious.

  2. griffen

    It seems as though, to my observation from the political spectrum any rate, the Biden administration wants to have their cake and make sure everyone knows this cake is the best ever served to an American public. Seeing a brief video clip featuring Janet Yellen, by example, she seems a little sanguine about the (slightly) above estimates CPI print announced this week. Okay it’s one month, anecdotally housing and OER perhaps is reflective of pricing imperative from landlord.

    What no one in the administration will explain is yet more increases in the insurance of stuff, whether that it is your vehicle or your home / dwelling or a single family townhouse rental (long term investments, not a flip). I suspect the theme of “inflation is down” will need a rewrite in the coming months but I reserve my ability to be wrong about the future. I’d also like to see coverage about the funding of projects via the Inflation Reduction Act being a pro-cyclical industrial policy and that may prove to be the fly in the wheel.

    Last thought…US equity market mavens want or wish for Federal Reserve rate cuts being the tonic to cure any ills. Will the Fed be resilient in not doing so, until they see the 2.0% to 2.5% inflation bogey securely in their grasp?

  3. eg

    This is why I have concluded that inflation is always and everywhere a distributional struggle and “independent” central banks are, by design, aristocratic institutions inimical to labour.

  4. Mikel

    Restrictive or unrestrictive – the central banks’ policies aren’t about the uplift of labor.

    In the US, the downward trend in worker participation rates accelerated post-2000, even during the hyper easing after 2008. This chart doesn’t go back to the 1950s, but that one is even more eye opening about the trend. These days, the financial press narrative makes improvements over the Covid dips and distortions seem like a win. But the overall trend…

    And that goes for more than the worker participation example.

    As another example, I don’t know what to think about Japan. But they have hyper easing conditions and are still going into recessions. Of course, as noted in the article, the speculators get to live in another world.

  5. aj

    I prefer to discuss “price increases” instead of “inflation” because inflation has been used as a boogeyman term for so long. My personal semantics aside, price increases are always always have a two-sided effect. 1) Someone is paying more money; their expense goes up. 2) Someone is getting paid more money; their income goes up.

    The follow-up questions should then be whose expenses go up and whose income goes up. Taking groceries for example, we know whose expenses go up: the consumer. But whose income goes up? It’s not the workers. It’s not the grocery stores. It’s not the farmers. It IS the large production conglomerates.

    Let’s look at Cal-Maine Foods, the largest egg producer in the US. In 2021, their Gross Profit was $160m and their margin was about 12%. In 2022 it was $337m (19%) and in 2023 it was $1.197 billion (38%). They claim it was due to egg shortages, which caused prices to go up. However, their price per egg was roughly the same. Their sales units actually went up, the price they charged more than doubled, leading to them tripling their gross margin %.

    I think it’s debatable whether increasing interest rates impacts employment (we’ve seen the opposite over the last couple of years), but it’s still the intent. The Fed is trying to reduce prices by reducing wages, which is not the source of the price increases in the first place. No wonder it has had zero impact.

    1. Korual

      Yes, even at high school they get taught the difference between price rises and inflation, micro and macro. My own rule is if wage increases are not as high as CPI price rises then it isn’t inflation. There is no wage price spiral.

      The biggest price rises for real people have been housing costs. When interest rates are increased these prices go up. Even as wages are suppressed.

      Try telling a central banker though.

      1. aj

        Agreed Korual. In my opinion, trying to combat price increases by raising interest rates is like saying “stuff is getting more expensive (inflation), so we need to make it even more expensive (raising rates), so it doesn’t get more expensive. (stop inflation)”

        Housing costs really hit home here. Home prices were on a tear, so they raised rates. Now the actual selling prices of a house has stopped increasing as dramatically, but my monthly cost on a new mortgage is now higher than it was before (for the same price house). Since households don’t get to pay cash for a mortgage, the end result of raising rates is to make buying a house even more expensive than it was before.

        1. digi_owl

          Interest is a demand side adjustment (make loans more expensive, less loans, less money chasing goods).

          But what is happening right now is a supply side price hike. Something that according to orthodox theory the free market should take care of by having new sellers step up to undercut those that try to hike the price.

          But if that is not happening then there is either collusion among the sellers, or the starting cost for new sellers are too high.

  6. Bob

    Great article. The author explodes the myth that markets fulfill their basic social function of determining price through supply and demand in the real economy. Actually it’s the speculators in the financial sector who determine most prices in a financialized economy. These very same speculators are the main cause of increased economic instability in the world.

    When prices are determined by speculators and when our culture is driven by greed and the lust for accumulation it’s no wonder that policy’s only answer to inflation is to try and repress wages by raising interest rates. This is all part of capital’s millennial old push for cheaper labor to feed their greed.

  7. JonnyJames

    “…US reliance on the Fed (as opposed to other means) to combat inflation via its blunt instrument of interest rates has the effect of whacking labor while typically not addressing immediate causes…”

    I recall Michael Hudson pointing this out when the Fed first started raising interest rates. There was a quote from Powell used, but I can’t recall the exact wording. Interest rate increases are not about combating inflation at all, but rather keeping wages down. The price gouging, and market abuse are perfectly fine and continue.

    In a simple way, we can see how this benefits the oligarchy: corporate profits, price-gouging, unearned income etc. are up. If wages can be kept down, labor can be squeezed even more, and profits further increased (at least in the short term). The stock goes up, (plus more buy-backs etc.) while the cocaine and Champagne flow. Good for the financial parasites and extortionists, not so good for the vast majority. What is good for stock and bondholders is good for the nation, at least that is the prevailing message in the media.

  8. JonnyJames

    Almost forgot: thank you Yves for the Werner link, I had not seen that.

    As the old Police song goes: “too much information running through my brain, too much information, it’s driving me insane”

    Just the breadth and quantity of information on NC alone can be overwhelming.

  9. Revenant

    If you believe in the market (clap your hands if you believe in Tinkerbelle, audience!), then you need to believe that the one “coordinating” mechanism by which myriad microeconomic supply and demand decisions converge on an optimum is the price signal. Supposedly, communist central planning foundered on the lack of price signals (and management measures like the tonnage (!) of television set production).

    How, therefore, can inflation be bad macro economically? Distributionally bad, yes. Bad in the short run, yes. But essentially to the efficient allocation of capital in the long run. Shortage if carrots? Plant more and import some. Expensive architects? Train more. And so on. If there are distributional consequences, resolve them with fiscal policy instead.

    Raising interest rates is an admission that Western Central Banks DO NOT BELIEVE in markets. It would appear they believe in “sound money”, which is a polite way of saying high returns on existing fixed and financial assets. They certainly don’t want to see high prices lead to new fixed investment and god forbid the formation of new real capital (with which incumbents would have to compete) rather than the creation of more financial claims on the existing stock of assets, which raises their price for the insiders….

    1. deplorado

      Fantastic comment. This is it:

      “Raising interest rates is an admission that Western Central Banks DO NOT BELIEVE in markets. It would appear they believe in “sound money”, which is a polite way of saying high returns on existing fixed and financial assets. They certainly don’t want to see high prices lead to new fixed investment and god forbid the formation of new real capital (with which incumbents would have to compete) rather than the creation of more financial claims on the existing stock of assets, which raises their price for the insiders….”

  10. Susan the other

    whoa! why are the shortest posts usually the deadliest? this one is a keeper. Very Michael Hudson. Just wondering about the foundation of monetary value: should we counter asset inflation beyond our almost benign asset tax? (What exactly is an asset? Not to mention wtf is a tax?) and then just accommodate ourselves with sufficient MMT? (Answer:Yes, duh!) Because when it comes to “assets” we are very soon to realize that our greatest assets are each other along with our dedication to nature and the environment. At which point the value of money is far more intricate and benign than it is now. Today, the value of money is an almost-living troglodyte zombie – not even a human one… but that might be temporary comedy and god willing, soon to be gone.

    1. eg

      Where “the value of money” is concerned, I’m with Mosler: the state as monopoly issuer of the currency (and that includes credit issuance by its chartered commercial banks) sets the “value” of the currency by what it is willing to pay for goods and labor from the private sector.

      Thus the state as monopolist sets the “price” of money, and the value of everything else is determined as a function of relative pricing.

      1. skippy

        Yes the state sets the price and market the volume …. only fly in that is pay days for a few and chump change for the unwashed …

        Distribution of funds is not about a functional socialite, just graft for the taking and lord over others … I feel good now …

  11. Jeremy Grimm

    This sentence from the last paragraph of this post says all that is necessary at this juncture:
    “Such policies imply a wide redistribution of power in the economy and in society at large. They have no possibility of being implemented if not supported by a widespread recognition of the failures of Neoliberal theories and policies, and this in turn requires turning upside down some established pillars of mainstream economic culture.”
    Neoliberalism is NOT dead nor diminishing and few options remain. The ‘Whirlwind’ is indiscriminate in its patterns of destruction. But what else is left to those who will not bow to the short-term self-serving insanities of our Elite? I am old and extremely uncomfortable with the future I foresee.

    1. skippy

      Its been a heck of thing to watch over a few decades now, some econ dept that has people critical of orthodox or neoliberal ideas get de-funded or restructured for market reasons and oops there goes your job …

  12. skippy

    Basically orthodox economics is a social control policy based on ideology and not functional economics …

    Funding and networks were used to facilitate gaining dominance in academia and then via MSM to control the social narrative.

    As luck would have it – Some of the favourite arguments used among these Keynesophobics to fight it are the ‘doctrine of sound finance’ and the need for austerity.

    1. skippy

      I would like to post this in reference to the article above to highlight the political back drop …

      It should be first stated that, although most economists are now agreed that full employment may be achieved by government spending, this was by no means the case even in the recent past. Among the opposers of this doctrine there were (and still are) prominent so-called ‘economic experts’ closely connected with banking and industry. This suggests that there is a political background in the opposition to the full employment doctrine, even though the arguments advanced are economic. That is not to say that people who advance them do not believe in their economics, poor though this is. But obstinate ignorance is usually a manifestation of underlying political motives …

      Clearly, higher output and employment benefit not only workers but entrepreneurs as well, because the latter’s profits rise. And the policy of full employment outlined above does not encroach upon profits because it does not involve any additional taxation. The entrepreneurs in the slump are longing for a boom; why do they not gladly accept the synthetic boom which the government is able to offer them? It is this difficult and fascinating question with which we intend to deal in this article …

      We shall deal first with the reluctance of the ‘captains of industry’ to accept government intervention in the matter of employment. Every widening of state activity is looked upon by business with suspicion, but the creation of employment by government spending has a special aspect which makes the opposition particularly intense. Under a laissez-faire system the level of employment depends to a great extent on the so-called state of confidence. If this deteriorates, private investment declines, which results in a fall of output and employment (both directly and through the secondary effect of the fall in incomes upon consumption and investment). This gives the capitalists a powerful indirect control over government policy: everything which may shake the state of confidence must be carefully avoided because it would cause an economic crisis. But once the government learns the trick of increasing employment by its own purchases, this powerful controlling device loses its effectiveness. Hence budget deficits necessary to carry out government intervention must be regarded as perilous. The social function of the doctrine of ‘sound finance’ is to make the level of employment dependent on the state of confidence.

      Michal Kalecki – Political aspects of full employment

      “The social function of the doctrine of ‘sound finance’ is to make the level of employment dependent on the state of confidence.”

      Let that soak in for a moment … especially the term ***sound*** …

      What financially sound means:

      Being financially sound means that you consistently make good financial decisions that increase your net worth, and you’re able to maintain this state for the foreseeable future.

      This is juxtaposed by Noise and Information in financial markets [Fischer Black 1986]

      None of this has any connection to society[.] Its I make packet and everyone else can die in a ditch, reality that is detached and blinkered of any thing that might in the long term cause broad social or economic dysfunction.

      I’ll stop now before I really get going …

    2. eg

      Endorsed. The neoclassical orthodoxy is a normative project which mendaciously hides its moral pronouncements by burying them in the assumptions (which are NEVER allowed to be examined) underpinning their fancy (but usually second rate, especially where stock flow consistency is concerned) mathematical models.

      It’s a priesthood, not a scientific endeavour.

Comments are closed.