On inflation and bicycles without brakes
Last week the Federal Reserve (the U.S. central bank), for the fourth time this year raises the benchmark interest rate. This time by a respectable three-quarters of one percent (0.75%). The rate hike is a monetary policy tool to try to curb inflation. The objective is that the rate hike will make credit more expensive, that these more expensive credits will induce a cooling of the economy. And this cooling will lead to a fall in inflation. But this is easier said than done.
We have already explained that the current inflation has two main causes. One, the slow start of the global supply side of the post-pandemic economy. In particular, logistical bottlenecks in supply chains. This cause is complicated and aggravated by the war in Ukraine, which reduces food, fertilizers and oil in that part of the world (Ukraine is Russia's California, as Manuel Escohotado used to say).
The other cause, in my opinion more serious and lasting, is the excessive monetary expansion, generated mainly by the American government. The more money circulating, as we have expressed in previous installments, the less money is worth and prices go up.
This inflationary situation is complex and there is no manual to handle it. Let me explain better. When there is inflation, say 5% per month, if you spend $100 per month on food, you will now have to spend $105. Or, just buy $100 and so your purchases go down and the grocer is affected, OR, you can buy the same groceries for $105, In this case, the grocer is not affected, but something else is affected, where you got the $5 for the groceries. By affecting one or the other you reduce the finances of one or both of them. And we see how, without affecting the total number of dollars, you are on the way to a contraction of the economy. The next month the drama repeats itself and so on.
Since many countries do not want to see a fall in consumption and production, through their central bank they issue more money to compensate for that lost 5% in the short term. But that just adds fuel to the fire. And why? Because issuing more money to compensate for what was lost is going to keep inflation at the same pace it is at. And if this exercise is repeated month after month, inflation will continue to grow, as well as triggering other evils. As we explained before, inflation also affects interest rates, which soon aggravate the situation.
