American countries, and totally contrary to the cultural stereotypes of the hyper-saving, prudent East Asian versus fun-loving, profligate Latinos (more on cultural stereotypes in chapter 9). In the 1960s, Korea’s inflation rate was
With these examples, I am not arguing that all inflation is good. When prices rise very fast, they undermine they very basis of rational economic calculation. The experience of Argentina in the 1980s and the early 1990s is quite illustrative in this regard.[12] In January 1977, a carton of milk cost 1 peso. Fourteen years later, the same container cost over 1 billion pesos. Between 1977 and 1991, inflation ran at an annual rate of 333%. There was a twelve-month period, ending in 1990, during which actual inflation was 20, 266%. The story has it that, during this period, prices rose so fast that some supermarkets resorted to using blackboards rather than price tags. There is no question that this kind of price inflation makes long-range planning impossible. Without a reasonably long time-horizon, rational investment decisions become impossible. And without robust investment, economic growth becomes very difficult.
But there is a big logical jump between acknowledging the destructive nature of hyperinflation and arguing that the lower the rate of inflation, the better.[13] As the examples of Brazil and Korea show, the inflation rate does not have to be in the 1–3% range, as Stanley Fischer and most neo- liberals want, for an economy to do well. Indeed, even many neo-liberal economists admit that, below 10%, inflation does not seem to have any adverse effect on economic growth.[14] Two World Bank economists, Michael Bruno, once the chief economist, and William Easterly, have shown that, below 40%, there is no systematic correlation between a country’s inflation rate and its growth rate.[15] They even argue that, below 20%, higher inflation seemed to be associated with higher growth during some time periods.
In other words, there is inflation and there is inflation. High inflation is harmful, but moderate inflation (up to 40%) is not only not necessarily harmful, but may even be compatible with rapid growth and employment creation.We may even say that some degree of inflation is inevitable in a dynamic economy. Prices change because the economy changes, so it is natural that prices go up in an economy where there are lots of new activities creating new demand.
But, if moderate inflation is not harmful, why are neo-liberals so obsessed with it? Neo-liberals would argue that all inflation – moderate or not – is still objectionable, because it disproportionately hurts people on fixed incomes – notably wage earners and pensioners, who are the most vulnerable sections of the population. Paul Volcker, the chairman of the US Federal Reserve Board (the US central bank) under Ronald Reagan (1979–87), argued: ‘Inflation is thought of as a cruel, and maybe the cruellest, tax because it hits in a many-sectored way, in an unplanned way, and it hits the people on a fixed income hardest’.[16]
But this is only half the story. Lower inflation may mean that what the workers have already earned is better protected, but the policies that are needed to generate this outcome may reduce what they can earn in the future. Why is this? The tight monetary and fiscal policies that are needed to lower inflation, especially to a very low level, are likely also to reduce the level of economic activity, which, in turn, will lower the demand for labour and thus increase unemployment and reduce wages. So a tough control on inflation is a two-edged sword for workers – it protects their existing incomes better, but it reduces their future incomes. It is only the pensioners and others (including, significantly, the financial industry) whose incomes derive from financial assets with fixed returns for whom lower inflation is a pure blessing. Since they are outside the labour market, tough macroeconomic policies that lower inflation cannot adversely affect their future employment opportunities and wages, while the incomes they already have are better protected.
Neo-liberals have made a big deal out of the fact that inflation hurts the general public, as we can see from the earlier quote from Volcker. But this populist rhetoric obscures the fact that the policies needed to generate low inflation are likely to reduce the future earnings of most working people by reducing their employment prospects and wage rates.
Upon taking power from the apartheid regime in 1994, the new ANC (African National Congress) government of South Africa declared that it would pursue an IMF-style macroeconomic policy. Such a cautious approach was considered necessary if it was not to scare away investors, given its leftwing, revolutionary history.
In order to maintain price stability, interest rates were kept high; at their peak in the late 1990s and the early 2000s, the real interest rates were 10–12%. Thanks to such tight monetary policy, the country has been able to keep its inflation rate during this period at 6.3% a year.[17] But this was achieved at a huge cost to growth and jobs. Given that the average non-financial firm in South Africa has a profit rate of less than 6%, real interest rates of 10–12% meant that few firms could borrow to invest.[18] No wonder the investment rate (as a proportion of GDP) fell from the historical 20-25% (it was once over 30% in the early 1980s) down to about 15%.[19] Considering such low levels of investment, the South African economy has not done too badly – between 1994 and 2005, its
Unless South Africa is going to engage in a major programme of redistribution (which is neither politically feasible nor economically wise), the only way to reduce the huge gap in living standards between the racial groups in the country is to generate rapid growth and create more jobs, so that more people can join the economic mainstream and improve their living standards. Currently, the country has an
In most countries, firms outside the financial sector make a 3–7% profit.[20] Therefore, if real interest is above that level, it makes more sense for potential investors to put their money in the bank, or buy bonds, rather than invest it in a productive firm.Also taking into account all the trouble involved in managing productive enterprises – labour problems, problems with delivery of parts, trouble with payments by customers, etc. – the threshold rate may even be lower. Given that firms in developing countries have little capital accumulated internally, making borrowing more difficult means that firms cannot invest much. This results in low investment, which, in turn, means low growth and scarce jobs. This is what has happened in Brazil, South Africa and numerous other developing countries when they followed the Bad Samaritans’ advice and pursued a very low rate of inflation.
However, the reader would be surprised to learn that the rich Bad Samaritan countries, which are so keen to preach to developing countries the importance of high real interest rates as a key to monetary discipline, themselves have resorted to lax monetary policies when they have needed to generate income and jobs. At the height of their post-Second-World-War growth boom, real interest rates in the rich countries were all very low – or even negative. Between 1960 and’73, the latter half of the ‘Golden Age of Capitalism’ (1950–73), when all of today’s rich nations achieved high investment and rapid growth, the average real interest rates were 2.6% in Germany, 1.8% in France, 1.5% in the USA, 1.4% in Sweden and -1.0% in Switzerland. [21]
Monetary policy that is too tight lowers investment. Lower investment slows down growth and job creation. This may not be a huge problem for rich countries with already high standards of living, generous welfare state provision and low poverty, but it is a disaster for developing countries that desperately need more income and jobs and often are trying to deal with a high degree of income inequality without resorting to a large-scale redistribution programme that, anyway, may create more problems than it solves.
Given the costs of pursuing a restrictive monetary policy, giving independence to the central bank with the sole aim of controlling inflation is the last thing a developing country should do, because it will institutionally entrench monetarist macroeconomic policy that is particularly unsuitable for developing countries. This is all the
