Stagflation Comes from Exorbitant Money Creation and Unhampered Government Spending

The Keynesian “stimulus” insurance policies were suppose to reinvigorate the economy

Too much government spending and loose monetary policy lead to rising prices coupled with falling economic growth prices.

All Keynesian roads result in stagflation. It is the result of economic mismanagement. Again and again, the belief has been proven wrong that central bankers could guarantee the particular so-called price stability  which fiscal policy could prevent economic downturns. The present turmoil is one more piece of proof that interventionist monetary plus fiscal policies are disruptive. Instead of a permanent boom, the end result is stagflation.

Stagflation— a Keynesian Curse

“ Stagflation” characterizes a good economy that is plagued by pumpiing combined with stagnation. In this case, the traditional macroeconomic toolkit of monetary and fiscal policy features no avail.

Rising price inflation prices and a tanking economy would be the results of the policy mix of the past decades. It has become common to believe that expansive monetary and fiscal policies would not cause price inflation. As recent as 2020, the economic policy implemented the false consensus that will combatting the fallout through the lockdowns with additional money development and higher government spending would lead to an economic recuperation without higher price inflation. It was assumed that what worked in 2008, would certainly also function in 2020. However , policymakers ignored the between the two episodes.

In the aftermath of the  financial crisis of 2008 , the stimulation policies did not turn into cost inflation right away because the recently created money remained mostly in the financial sector and did not spill over to the real economy in a big way. At that time, the main effect of the policy of low interest rates has been to support the stock market and also to provide a windfall to monetary investors. While Wall Street  flourished , Primary Street was left for the sidelines and while profits surged, wages remained stagnant.

Compared to the financial crisis of 2008, the difference is that the manufacturing side of the economy will be severely damaged this time. The particular crisis of 2008 left the capital structure of the genuine economy intact. Due to the  lockdowns , nevertheless , this is no longer the case. Consequently, severe interruptions of the global supply chains have occurred. In such a constellation, new stimulus measures have the effect to  weaken   further the economy. The current situation is more like the oil price shock in 1973. At that time, too, the exterior shock hit an economy rampant with liquidity. Exciting the economy by financial and monetary expansion created long-lasting  stagflation . Back then, along with “ stagflation, ” the term “ slumpflation” was coined to characterize an economy that is hooked in a deep slump plus gets devastated by price inflation.

Whenever stagnation and recession appear together with price inflation, the traditional macroeconomic policy becomes impotent. Applying the Keynesian recipe to an economy whose funds structure has been ravaged indicates inviting disaster.

Intentionally or by lack of knowledge, policymakers neglected the long-term effects of their doing. Going this wrong way resulted in such aberrations that policymakers and their intellectual bodyguards even tended to believe that some truth could be found in the alchemy of the so-called  modern monetary theory   and  market monetarism .

The consequences of these plan errors have now come to light. These are particularly grave because they were committed by all main central banks and the government authorities of all leading industrialized countries. They all follow the concept of “ inflation targeting . ” Other than timing, there has been not much difference among the plans of the major Western financial systems. Japan is a special case only insofar as its policymakers have applied the Keynesian recipe for over three decades chances are.

Let us take a look at Japan first and then on the United States.

Japan

Japan began with the using vulgar Keynesianism as early as within 1990. Faced with a slight downturn of the economy after the increase of the 1980s, the Japanese leadership did not want the economic climate to cool down but to go on with the show.

The government began to accelerate general public spending and increased the particular fiscal stimuli the much less its spending policy created the expected result of a fiscal recovery. Even when monetary policy fully supported the government’s expansive fiscal policy, the expected recovery did not appear.

The short run became the long run. The plan mix between fiscal and monetary policy has been going on over the past three decades. The Bank associated with Japan implemented a policy of extremely low interest rates and finally resorted to a policy of adverse interest rates (NIRP). In the meantime, public debt as a percentage from the gross domestic product (GDP)  rose   to 266 percent (see figure 1).

Figure 1: Japan:   Policy interest rate plus public debt as a % of  GDP

Figure 1
Source:   Investing Economics .

Despite the magnitude of the stimuli, this policy mix did not lift the Japanese economy out of its quagmire. In kampfstark contrast to the Japanese growth of the 1980s, economic growth has remained anemic in the past quarter of a century  (figure 2).

Figure 2: Japan:   Annual economic growth rates of real GDP

Figure 2
Source:   Trading Economics .

As an “ early starter” in applying vulgar Keynesianism as its macroeconomic policy focus, the Japanese economy seemed to be early to suffer from the stagnation of its productivity rates. Completely different from countries like the United States, France, Germany, and many other industrialized countries, which have continued with efficiency gains over the past decades, Japan has moved sideways right after it had begun using its extreme Keynesianism in the 1990s  (figure 3).

Figure 3: Efficiency per hour worked:   Germany, United States, France, Japan

Figure 3
Source:   Our World in Data .

It is important to remember that one of the most devastating effects of the Keynesian policy mix is its effect on productivity. The country’s long-run economic development is mostly the result of productivity increases. Labor productivity is the primary determinant of wages. A slowdown of productivity precedes the economic decline. Once the output per unit of input tends to fall, actually lower interest rates will not induce business investment. When govt jumps in to compensate for this particular “ lack of aggregate requirement, ” things get worse since governmental enterprises are fundamentally less productive than the private sector.

The United States

Confronted with the financial crisis associated with 2008, the US government decided to launch a series of stimulus packages. The particular American central bank offered full support of this policy and began to reduce drastically its interest rate.

As a result of these policies, exactely public debt to the GDP  rose   from 62. 6 percent in 2007 to over 91. 2 percent in 2010, achieving 100. 0  percent in 2012. The next two boosts arrived the wake of the insurance policies to counter the effects of the economic lockdowns, when the proportion of public debt to GDP rose to 128. 1 percent in 2020 and also to 137. 2 in 2021  (see figure 4).

Figure four: The United States:   Policy interest rate and federal debt as a percentage of GDP

Figure 4
Source:   Trading Economics .

In the face of the outburst of the financial market turmoil in 2008, the American central bank brought straight down its interest rate quickly from over 5 percent in 3 years ago to under 1 percent within 2008. After a short-lived period when the American central financial institution tried to raise the interest rates, the particular consequent market reaction of falling prices of bonds and stocks induced the Fed  to resume its policy of “ quantitative easing ” that combined low interest rates with the huge expansion of the monetary base. Trying to ease the economic effects of the lockdowns in early 2020, the Fed  decided   to go on with its expansive monetary plan. In due course, the central bank’s balance linen rose to $7. 17 trillion in  June 2020   and reached $8. 96 trillion in  April 2022 .

Figure 5:   Stability sheet of the US Government Reserve System

Figure 5
Source:   Trading Economics .

As figure  4  displays, the Fed had attempted to trim its balance page from 2015 to 2019 when it had brought throughout the sum of its assets in order to $3. 8 trillion within August 2019. Yet starting already in September 2019, many months before the lockdown was implemented, the balance page of the American central bank began to expand again plus reached over four trillion before the additional big raise happened due to the fallout in the lockdowns.

Because the time before the financial crisis associated with 2008, the  assets   of the Federal government Reserve System rose through $870 billion in August 2007 to $4. 5 trillion in early 2015 and also to around nine trillion ALL OF US dollars in early 2022.

Even when inflation prices began to rise towards the finish of 2020, the US central bank had kept the policy of  tapering   small and refrained from tightening. The particular monetary authorities had given up on the objective to rein within the money supply. Each time these people tried to tighten monetary policy, the financial markets began to tank and tended to crash. When the central bank began to raise its policy rate of interest, the particular bond market began to tank and took the shares down with it. In 2022, it was not different. However in early 2022, the policymakers could not shrink back. Distinctive from the episodes before, the cost inflation had begun to skyrocket.

In the first months of 2022, stagflation became fully noticeable. While price inflation went up, the rate of real economic growth began to fall. In the first quarter of 2022, the inflation rate relocated up to a rate of eight. 5 percent, while the real annual growth rate fell simply by 1 . 4 percent (see figure 5).

Figure 6:   United States: Policy interest rate and official consumer price inflation rate

Figure 6
Source:   Trading Economics .

With the global supply chains at this point in disarray, and nationwide protectionism on the rise, the assistance that will came from the expansion associated with international commerce after the crisis of 2008 is no longer with us. The lockdown of the economic climate has severely hurt a global system of  provide chains .   Today, a huge monetary overhang satisfies a shrinking production. The war in Ukraine, which started in February 2022, is not to blame for the distortions, albeit it will make them more severe.

Conclusion

The levee broke. Price inflation is on the rise. This is the result of the particular accumulation of liquidity which has been going over decades. There is the danger that things will get even worse because the world economy has been severely wounded by the lockdown. More so than only slight stagflation, a “ slumpflation” looms on the horizon as the entire world economy gets mired in the morass of a deep slump combined with steeply rising price inflation.

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