Why the left needs to take monetarism seriously
It matters how we approach questions of monetary and fiscal policy, because the livelihoods of many are at stake
It has been claimed in recent months, notably by commentators on the left, that the inflation besetting developed economies must be a supply-side phenomenon. Owing to lockdowns, labour shortages, and other disruptions caused by the COVID-19 pandemic, producers have been dealing with an above average cost of production, translating into higher prices for the consumer. Corporate profiteering has been rife, with companies exploiting global chaos to justify asking more for their products. No doubt there is truth in all this, but can it account on its own for the events we are witnessing? Long before it was thought the causes of inflation could manifest in this way, traditional economics had identified a different kind of mechanism behind increases in the price level. Inflation, so it was said, usually results from a rise in overall spending—in other words from more pressure on the demand side of the economy, enabling suppliers to bring up prices without diminishing sales. It occurs when, according to the economist’s adage, “too many dollars chase too few goods.”
In our own day, this view has become unfashionable among thinkers concerned for the welfare of low-income workers. The reasons for this are clear: the ‘demand’ theory of inflation now plays a key role in criticism directed by fiscal conservatives against the growth of government spending. Conservative Party leadership hopeful Pierre Poilievre, for example, has been particularly vocal in lambasting the Bank of Canada’s accommodative monetary policy over the past two years, which he views as the real root of our inflationary crisis. By funding an epoch-making federal deficit, he thinks the Bank of Canada has irresponsibly swollen the supply of money in the economy, leading to an inevitable decline in the purchasing power of the Canadian dollar. The question we must ask ourselves today is: could he be right, at least in part? And if so, what should a labour-oriented fiscal response to rampant inflation look like?
It matters how we approach questions of monetary and fiscal policy, because the livelihoods of many are at stake. Unchecked inflation is a serious burden on Canadian workers of modest means, who find themselves able to buy less and less with the money they take home from their jobs. Something must be done by elected officials to ease the difficulties they face, but no adequate solution will be found without first determining the nature of the problem. Much hangs in the balance. It is therefore important that we take the arguments of the fiscal conservative seriously—not because we view government spending as necessarily wrong (far from it), but because we need to be sure there is no truth in such arguments before rejecting them. Otherwise, we risk having an incomplete and ineffective understanding of our present challenges. Many people are struggling, and they will continue to struggle if we fail to get things right.
As it turns out, the principles espoused by today’s fiscal conservative when it comes to inflation represent a once commonly accepted economic orthodoxy. We tend to associate the demand theory of inflation with the ‘monetarist’ school of Milton Friedman, whose influence on economic thought in the late 20th century is well-known, but he was not its first, nor even its most famous proponent. Karl Marx, too, addressed the question of inflation in Capital, taking a similar view to that later adopted by the monetarists. In his discussion, he envisions a currency system based on a gold standard (the norm during Marx’s lifetime), where money is redeemable for a predetermined quantity of the precious metal. Just as when you debase gold coinage, lowering its value but increasing its nominal supply, when you increase the supply of paper money, it too loses value:
If the paper money exceed its proper limit, which is the amount in gold coins of the like denomination that can actually be current, it would, apart from the danger of falling into general disrepute, represent only that quantity of gold, which, in accordance with the laws of the circulation of commodities, is required, and is alone capable of being represented by paper. If the quantity of paper money issued be double what it ought to be, then, as a matter of fact, £1 would be the money-name not of one-quarter of an ounce, but of one-eighth of an ounce of gold. The effect would be the same as if an alteration had taken place in the function of gold as a standard of prices. Those values that were previously expressed by the price of £1 would now be expressed by the price of £2.
For Marx and his successors in the field of economics, money is a commodity with a determinate supply, which serves to represent the value of other goods and thus behaves as a medium of exchange. Since this is its chief function, it is possible for money to be a purely abstract representation of value:
Being a transient and objective reflex of the prices of commodities, it serves only as a symbol of itself, and is therefore capable of being replaced by a token. One thing is, however, requisite; this token must have an objective social validity of its own, and this the paper symbol acquires by its forced currency.
Today, we live under just such a monetary regime. Marx’s “token with objective social validity” is our fiat money, and its value and currency are enforced by the state responsible for its issuance. If, for whatever reason, the state chooses to issue more currency and put it into circulation, then inflation occurs and units of that currency lose objective value. Much as it may be uncomfortable to admit, Marx had pretty well the same view of money as a present-day fiscal conservative.
History continues to show that this view of money creation and its consequences can be a powerful theory for understanding modern economies. Canada and the United States are now experiencing the highest inflation on record since the 1980s, following an equally record-setting bout of monetary stimulus administered to their economies. In Canada, the latest figures indicate an increase in the Consumer Price Index (CPI) of 6.8 percent over the period from April 2021 to April this year. Correlation with the massive $400 billion increase in the Bank of Canada’s balance sheet due to quantitative easing and the Liberal government’s $322 billion COVID-19 recovery spending is too obvious to ignore. During most of 2020 and into 2021, the central bank was purchasing billions of dollars of federal government debt on a weekly basis and lowered its overnight interest rate to 0.25 percent—the same rate as during the 2008-2009 financial crisis and the lowest ever. The purpose of this was to make cash more freely available to borrowers, businesses and individuals alike, and to keep economic activity afloat despite a precipitous recession. Thanks in part to cash handouts and attractive borrowing rates, the savings of the average Canadian household relative to its income shot up to 27 percent in mid-2020 and stayed above 10 percent for the following year, while household debt nearly doubled in the same period. At the same time, corporate cash reserves went up dramatically, alongside corporate debt. As you would expect, 2021 saw a resultant spike in nominal GDP—the amount of Canadian dollars spent in the economy in a given year—over pre-pandemic levels. More money means more spending. From the point of view of the monetary theory of inflation, the writing was on the wall.
So what is the alternative explanation? Last December, when the country’s inflationary woes were still fresh, a piece published in Passage advised against interpreting inflation as a demand-driven phenomenon. The author, Adam King, is in agreement with Deputy Prime Minister Chrystia Freeland that the rise in consumer goods prices that Canadians are experiencing is due above all to supply-chain complications and the sky-rocketing cost of energy. Let me say again: there is truth to this explanation. But it is only half the truth.
One of King’s central claims is that, according to data published by Statistics Canada, the price of gasoline in October 2021 was responsible for 42 percent of inflation, while the price of meat accounted for another 10 percent. At that time, CPI inflation was still only at 4.7 percent relative to 12 months earlier. King goes on to note that, when you discount these commodities in the calculation of the CPI, you end up with a core inflation rate of only 3.3 percent—that is, the increase in prices for goods not considered ‘volatile,’ such as fuel and food are. The reality, however, is that 42 and 10 percent represent the annual increase in the prices of these commodities since the end of 2020 (their contributions are somewhat less).
King is right that such drastic increases could well be sector-specific and therefore unrelated to a generalized increase in demand—which is why its important that we look at the other goods in the CPI price-basket. In October 2021, the cost of food was up 3.8 percent over the previous year and shelter cost 4.8 percent more, both figures comparable to overall inflation at 4.7 percent. In April, those rates reached 8.8 percent and 7.4 percent, outstripping overall inflation at 6.8 percent. What this tells us is that Canadians, last year and today, have been paying broadly inflated prices for the everyday goods and services that count most in maintaining their standard of living. The generality and persistence of the phenomenon make it unlikely that this can be explained merely as a consequence of costly supply-side complications, exacerbated by corporate machinations.
An adequate understanding of inflation from a policy perspective must take into account both demand and supply factors. Inflation describes the behaviour of prices, and in a market economy such as Canada’s, prices are mainly set by supply and demand. If supply decreases while demand remains constant, prices will undoubtedly go up, but by the same logic a rise in prices should be even stronger where a decrease in supply is accompanied by an increase in demand. Arguably, this is what has happened in the last two years since the start of the pandemic. While dealing with supply-side shortages and increased transportation costs, companies that produce and sell goods have been gifted with renewed demand for their products. A wave of spending catalyzed by re-openings and fuelled by consumer savings has swept our economy, and corporations have been making a killing compared to their pre-pandemic performance: their profit margins in 2021 were 68 percent greater than in 2019. It should be emphasized that this would not be happening if people were not going out and buying their products. Corporate revenues do not exist in a vacuum. In addition, profiteering via price hikes is scarcely sufficient to account for the extra proceeds that corporations are pocketing. A five percent rise in prices does not cause double-digit profit increases, especially when higher supply costs are factored in. The truth is much of the fat profit margins of last year must be due to vigorous consumer demand generated by extraordinary fiscal stimulus. Sellers raise prices because they can, which is to say, when demand continues to exist for their goods even if they are more expensive. Such has been the case since the economic recovery kicked off, and now we are coping with the consequences.
None of this should come as a surprise. Monetary stimulus is by definition designed to stimulate economic activity through encouraging spending. Indeed, in 2020 the Bank of Canada was worried about inflation dropping too low, which was part of the reason it maintained a low policy rate for as along as it did. In this they were justified to an extent. According to a widely accepted economic theory proposed by John Maynard Keynes in the early 20th century, low inflation can spell trouble for working people when it follows contractions in credit (that is, in the supply of money), which motivate employers to cut costs by reducing their labour forces. Keynes said that an appropriate policy would therefore be to maintain the availability of credit at a reasonable level in order to keep people employed. Conversely, if the economy is at full employment, low interest rates cannot foster more employment or greater productivity, and serve only to strengthen inflation. The central banker needs to strike a balance between interest rates that are low enough for companies to meet their labour costs while enjoying increased productivity, and rates that are high enough to avert runaway inflation.
It is essential to understand that inflation has no causal role in this process, being simply the effect by which healthy availability of credit and economic growth are measured. Higher spending can lead to higher economic activity and higher growth, but also leads to higher demand and thus to higher inflation. The crucial error committed by the Bank of Canada in 2020 was to think they could meet their two percent inflation target using the traditional method of funnelling money into the economy, at a time when what was behind declining demand was not actually a lack of funds. During a lockdown, with ordinary services suspended and access to certain goods limited, people are not allowed to spend on many things they normally buy. No amount of disposable cash will fix this until the barriers to commerce have been lifted, and meanwhile inflation naturally declines. Instead, what the Bank of Canada and Liberals achieved was to dam up piles of cash that had to wait until the economy re-opened before they could be unleashed on the market. When vaccination and re-opening came around in 2021, whatever portion of this money had not been invested in stocks and real estate (both inflated as a consequence) was finally able to circulate in the economy, generating much of the consumer price inflation we see today. This was not helped by the fact that in recent years, barring the pandemic, Canada has had historically low levels of unemployment. There are even labour shortages in certain sectors. Under these conditions, stimulus was bound to place excessive upward pressure on prices.
It should be clear how none of what I have described really serves the goals of a fairer society, characterized by greater economic and social equality. On the contrary, the money that was ‘printed’ by the Bank of Canada in 2020 has largely ended up inflating asset prices and bolstering corporate balance sheets. All the while, consumers pick up the bill by paying increased prices on goods. That the Bank of Canada’s monetary response to the pandemic feeds wealth inequality is no secret and has even been publicly admitted by Bank of Canada Governor Tim Macklem. That said, acknowledgement of these undesirable effects must also extend to the fiscal policy of our federal government. If the central bank’s unprecedented acquisition of financial assets and its easy lending have made room for more investment demand, helping to jack up stocks and house prices, our elected officials have done something similar for consumer products. For every dollar of Canada Emergency Response Benefit (CERB) spent at grocery stores, retail outlets, and gas stations, a dollar is added to corporate profits. This wouldn’t be such a problem, if there were a more effective way of redistributing this money once it becomes a part of sales revenue. But there’s the rub. Government support for those grappling with economic duress is a great thing and deserves to be applauded, but not if these same people have to pay for it indirectly in the price of consumer products. So long as heavy fiscal expenditure is not accompanied by a redistributive tax program, it does little in the long run to change the lives of working people for the better. And if it overshoots what is called for, then it actually harms them. In Keynes’ words:
By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method, they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some.
The only way to redress the balance is to tax those who have profited unfairly from inflationary conditions. If we want to help ordinary working people, this is what we should be pressing for more than anything. Fiscal profligacy—by which I mean a government’s spending freely with no plan to pay back its debt—cannot be condoned.
Where should we start then? We need to raise corporate tax rates, of course. We need a government that will hold corporations to task when they find loopholes to avoid paying the taxes that have been set. We need prudential, ad hoc taxation measures when corporate business is booming to fund ad hoc spending when times get hard. We need to be tough on multinationals who often pay no taxes at all. We need more progressive taxation for high-income earners, with income tax brackets adjusted to the rate of inflation in order to protect the real wages of those near the bottom of the income scale.
Other revenue sources exist as well. Increased taxation on rental incomes should be a priority, with rent-control measures introduced in urban areas to keep housing affordable. Rents and sales in Canada’s highly speculative real estate market raked in $268 billion last year, an enormous 13.3 percent of GDP. Property tax on vacant and secondary residences should be put up.
This is by no means a comprehensive list of the places government might look to cover its current debt and future deficits, but I think readers will agree it is already quite substantial. A responsible and progressive fiscal policy would weigh all these options in an effort to limit as much as possible our dependence on the money machine of the central bank. The alternative is debt monetization via inflation, and that means the less well-off pay the price, while anyone lucky enough to own property gets richer.
David Douglas is a Canadian researcher and doctoral student in philosophy at the École Pratique des Hautes Études in Paris. He takes an active interest in economics and contemporary politics.