Nachricht | Economic / Social Policy - Globalization - Distribution Crisis The Inflation Enigma

An honest debate on the causes of the current wave of price increases is still in its infancy


Graffiti in Wien zeigt eine Geldmaschine, die Euroscheine ausspuckt, 2018
Die zirkulierende Geldmenge bestimmt nicht das Preisniveau. Graffiti in Wien, 2018, Foto: IMAGO / Steinach

What is driving the current inflation surge? Mainstream economic theories do not and cannot account for the recent price rises facing consumers around the world. In fact, the economic policy recommendations that flow from these theories only add to the misery of people forced to live on low incomes.

Thomas Sablowski is Senior Fellow for the Political Economy of Globalization at the Rosa Luxemburg Foundation’s Institute for Critical Social Analyis in Berlin.

Translated by Hunter Bolin and Sonja Hornung for Gegensatz Translation Collective.

To formulate a policy response to inflation in the interests of the many rather than the profit-seeking few, we first need to understand what is behind it.

Did the Central Banks Print Too Much Money?

One of the most widespread misconceptions is that central banks have “printed too much money”. Several aspects of this theory do not add up.

First of all, cash accounts for a mere fraction of the total money in existence. In today’s computer age, most money exists only in the form of demand deposits booked into bank accounts at the click of a button. But that’s not the issue at the heart of the matter. Underlying the entire theory is the assumption that the money supply determines the price level: if the money supply increases, then so does the general price level and with it the inflation rate.

This is what’s known as the “quantity theory of money”, and it forms a central pillar of the dominant “neoclassical” economic theory. The quantity theory claims that the product of the money supply and the velocity of money in circulation is equal to the product of the price level and the quantity of traded goods. The money supply is considered the independent variable and the price level the dependent variable. Inflation accordingly arises from an excessive increase of the money supply.

The theory has circulated in different forms, such as those posed by the Austrian School of national economics and by “monetarists” such as Milton Friedman. The central bank is tasked with avoiding inflation by controlling the money supply. However, the quantity theory is neither theoretically tenable nor empirically sound.

The first assumption that must be called into question is that the entirety of the existing money supply is in circulation at any one time, i.e. that all money exists as a means of purchasing goods. In fact, we know that a portion of the money does not create demand for goods because it remains within the financial sector, that is to say it is saved and does not enter into circulation. At best, the prices of goods can be influenced only by the portion of the money supply that is actually used to purchase them.

Yet this also raises the question of the relationship between cause and effect: does the money supply determine the price level, or does the price level determine the money supply? With the exception of auctions and similar kinds of negotiations, the sellers of goods — usually companies –– fix the price of goods before they are sold. It is thus more plausible that the money supply in circulation adjusts to the sum of the prices of goods than, conversely, that the money supply determines the prices of goods.

Nor is there much empirical evidence to back up quantity theory and the explanation of inflation derived from it. Throughout the entire cycle beginning from the global financial crisis of 2008–2009 to the COVID-19 pandemic, we see that the money supply increased greatly in both the US and the Eurozone, while inflation rates remained at extremely low levels. The inflation rate in the Eurozone was consistently below the European Central Bank’s (ECB) 2-percent target, despite a loose monetary policy being put into effect. Although the money supply was increased, much of it did not flow into production, but rather remained within the financial sector or was used to purchase existing securities and real estate, driving up their prices.

In the last two years, the increase in money supply also tended to correspond with countervailing trends in terms of inflation. The money supply was increased in 2020 during the first phase of the pandemic as many states tried to combat the recession by introducing stimulus programmes. At the same time, monetary policy was again loosened, while lockdowns meant that companies and consumers tended to spend less and save more as a buffer against hard times ahead. Although the growth rate of the money supply declined in 2021 and 2022, the inflation rate rose in those same two years.

The next problematic assumption is that central banks can actually control the money supply. Of course, when there is a risk of deflation, the central bank can try to increase the money supply by lowering interest rates or buying government bonds in order to encourage investment. Conversely, when inflation rates are rising, it can raise base interest rates or sell securities to try to reduce the money supply.

The problem, however, is that the central bank has an at best indirect influence over commercial banks’ capacity to grant credits. Their practices are largely oriented towards profit maximization, and their calculations are not determined by central bank policy alone. Most of the money in circulation is not central bank money, but credit that has been created by private commercial banks.

Central banks intervene in an asymmetrical way: amid low profit rates and deflationary tendencies, it is generally easier to stifle the economy by raising interest rates than it is to encourage banks to free up more credit for companies in order to foster an expansion in production. The standard method central banks draw on in order to counteract high inflation rates is to raise base interest rates. Doing so, however, means risking a recession and an increase in unemployment.

Do Excessive Wage Rises Cause Inflation?

Another common theory about inflation؅ concerns what is known as the “wage-price spiral”. This theory, advocated by neoclassical economists and Keynesians alike, claims that inflation is caused by an excessive increase in wages: higher wages result in higher production costs, leading to higher prices. In terms of economic policy, it is argued that wage increases must be curbed should they exceed increases in labour productivity. The wage-price spiral premise quite obviously aligns with the interests of capital.

From a theoretical point of view, it is unclear whether, in a competitive economy, companies are even able to transfer rising labour costs onto product prices, or whether falling profit rates are far more the consequence of rising wages. Also unclear is the extent to which companies combat wage increases by using machines to replace the workforce, thereby cutting their wage expenses. Investments in optimization and rationalization could cause increased unemployment, weaken trade unions, and thus curb wage increases. It remains an open question whether the wage-price spiral even exists. In any case, the theory stipulates that only wage increases that exceed productivity growth lead to rising inflation rates. Whether they are more likely to cause profit rates to sink or inflation to rise is likely to depend on the conditions of competition.

While the gas crisis likely influenced inflation in the EU, it is more difficult to trace how the rise in energy prices has affected inflation in the US.

Moreover, here, too, the question of causality is relevant: high nominal wage increases could be a consequence of high inflation rates, rather than their cause. In any case, companies experience higher costs not only due to wage increases, but also from increasing costs for the means of production. This perspective is far more relevant to our current conjecture, especially taking into account the rising prices of energy derived from fossil fuel.

If we take a look at the actual development of wages in Germany,[1] for example we see the nominal wage bill increased by an average of 4.25 percent per year between 2013 and 2019. The Harmonized Index of Consumer Prices (HICP), the most common measure of the inflation rate in the European Union, rose by an average of only 1.15 percent per year during the same period. Real wages, i.e. the difference between nominal wages and the inflation rate, thus increased by more than 3 percent annually. Inflation remained low despite the significant increase in nominal wages.

During the 2020 pandemic, the nominal wage bill decreased by 0.24 percent. The consumer price index (CPI) for Germany increased by 0.4 percent. Employees thus suffered a 0.64-percent decrease in their real wages. In 2021, the nominal wage total increased by 3.5 percent compared with the shrunken baseline of the previous year. Thus, one can say that the increase in nominal wages still lagged behind the wage increases from 2013–2019. However, this was concurrently offset by a 3.2 percent increase in the CPI. In sum, wage earners only saw their purchasing power rise by 0.3 percent.

In 2022, nominal wages grew by 5.5 percent, but the CPI rose by 8.7 percent. This meant that employees suffered an average real wage loss of 3.2 percent. This demonstrates that there is no clear causal link between wage increases and inflation — the wage-price spiral does not exist. Rather, it seems that during certain phases of capitalist development, real wage increases are possible while inflation remains low. In the current phase of accelerated inflation, on the other hand, nominal wage increases have been unable to compensate for the rise in prices, and wage earners have ended up losing considerable purchasing power as a result. Thus, from the perspective of wage earners, what is needed is not lower but higher wage increases to correct the redistribution in favour of capital brought about by recent price increases.

There is another explanation for inflation which still maintains that wages are major drivers of inflation. Rather than pointing to cost pressures on the supply side, this theory emphasizes the pull of demand provoked by rising wages. In other words, an increase in wages would lead to an increase in demand for goods and services, driving up prices. This, however, ignores the fact that rising profits also create demand. If the share of wages in the value product rises, then the share of profits falls, and vice-versa — if the share of profits rises, then the share of wages falls. Prices can only be driven upwards if the combined purchasing power of wages and profits rises — and if production cannot keep up with this rise in purchasing power. The latter seems to be the crux of the matter in explaining the recent wave of inflation.

Is the War behind the Inflation Surge?

From time to time, certain figures in the German public sphere claim that the war in Ukraine and resulting sanctions imposed against Russia by the “West” and vice-versa are to blame for inflation. This is only partly correct.

Certainly, Russia’s cuts to exports drove up prices for fossil fuels, just as grain prices increased due to disruptions in Russian and Ukrainian supply chains. Statistically speaking, however, inflation rates began to rise as early as 2021, before the war in Ukraine escalated. This process began earlier in the US than in the EU.

In the US, the Personal Consumption Expenditures Price Index (PCEPI, a measure of inflation similar to the HICP) increased by 2.8 percent in March 2021, 4.8 percent in April, 5.9 percent in May, 6.3 percent in June, and 8 percent in December in comparison to the same months of the previous year.[2] In the EU, the rise in the HICP was above the ECB’s target inflation rate for the first time in May 2021, when it averaged 2.2 percent. It then climbed to 5.3 percent in December 2021. The fact that inflation in the EU followed the US trend indicates that the US still constitutes the dominant centre of the capitalist world economy, setting the pace particularly in the Atlantic region. It follows that the escalation of the Ukraine war did not trigger the rise in inflation rates, although it amplified them considerably.

By March 2022, the CPI in the US had risen by 9.8 percent and in the EU by 7.8 percent compared to March 2021. The first phase of inflation reached its preliminary peak in the US as early as June 2022, with a CPI rise of 10.1 percent in the EU. The CPI reached an initial peak only in October 2022, with average increase of 11.5 percent. The impact of the war on the inflation rate was clearly more marked in the EU than in the US. There, the sharp rise in demand following the 2020 recession, which was also boosted by the US government’s stimulus packages and could not be met by a corresponding expansion in production, played a greater role.

The energy crisis clearly played a more fundamental role in the EU, especially given the rise in gas prices. That said, it is important to note that gas prices in Europe already rose sharply in the summer of 2021. Russia is accused of having cut gas supplies to the EU as early as 2021 in order to force the approval of the North Stream 2 gas pipeline.[3] Once the war escalated, gas prices in the EU’s central hubs and on spot markets climbed to astronomical levels.

Gas prices also rose in the US, but not nearly to the extent that they did in the EU. Even when the gas price surged in the US in the summer of 2022, the spike still did not surpass the levels of previous peaks, such as those of 2005 or the summer of 2008. Incidentally, the same applies to the price of crude oil, which did not rise as much as the price of gas within the EU itself.

The monetarist theory of inflation, which is based on the quantity theory of money, and the wage-pressure theory, which is also advocated by Keynesians, cannot explain the recent rise in inflation rates.

It should also be noted that an increase in the price of fossil fuels alone cannot account for rising inflation rates, although fossil fuels are essential for many downstream sectors of the industry. Before and after the Great Recession of 2008–2009, drastic increases in fossil fuel prices were not associated with a correspondingly drastic rise in inflation. From 1991 to 2020, the inflation rate in the US stayed consistently below 4 percent, as is also true of the EU since the mid-1990s, barring 2008.

While the gas crisis likely influenced inflation in the EU, it is more difficult to trace how the rise in energy prices has affected inflation in the US. It is true that energy prices have also risen more sharply there than the prices of other commodity groups following a deep slump in the wake of the pandemic and the accompanying recession, namely by more than 50 percent between the fourth quarters of 2020 and 2021 and again by almost 30 percent between the fourth quarter of 2021 and second quarter of 2022.

Nevertheless, the “core inflation rate”, i.e. the increase in the consumer price index aside from the increases in energy and food prices, was still at 4.7 percent between Q4 2020 and Q4 2021 and between Q4 2021 and Q4 2022. In the 27 EU member-states, excluding energy and food prices, the consumer price index rose by only 1.8 percent in 2021 and 4.7 percent in 2022. By contrast, the consumer price index including food and energy prices increased by 5.3 percent in the US and by 2.9 percent in the EU in 2021, and by 8.7 percent in the US and 9.2 percent in the EU in 2022.

One possible explanation for the increase in energy prices even before the escalation of the Ukraine war could be a lack of investment in fossil fuels in recent years. Potentially, public discourse on climate policy has caused financial investors to reorient. How sustainable this will be remains to be seen. In any case, global investment in fossil fuel production fell from 905 billion US dollars in 2018 to 873 billion in 2019, before dropping again to 671 billion in 2020, according to data from the International Energy Agency. Thereafter, investments rose again, but at 852 billion dollars in 2022, they still sat lower than 2015–2019 levels.

The fact that the inflation coincides with gradual divestment from fossil fuel production points to the enormous challenges and risks posed by the envisaged “decarbonization” of the economy. If the production of renewable energy is not sufficient to avoid bottlenecks in energy supply, or if, for example, the production of metals necessary for “green” capitalism cannot be sufficiently increased, then we can expect inflation rates to rise again in the future.

Price increases are widely believed to be caused by the Ukraine war and the disruption of supply chains due to the pandemic. The various lockdowns, as well as events such as the six-day blockage of the Suez Canal by the stranded container ship Ever Given in March 2021, have underscored the volatility of the global production chains. The occurrence of bottlenecks in different sectors of production, such as the chip industry, is increasingly common.

The transformation of working conditions (the rise of the home office) and consumption patterns in the wake of the pandemic has led to a growing demand for computers and consumer electronics and thus for microchips, while the recent recession saw demand for automobiles briefly slump. Chip manufacturers adjusted accordingly, prioritizing demand from the computer and consumer electronics sectors. By the time demand for cars recovered, it was not possible to meet the automotive industry’s need for microchips.

A More Plausible Explanation

The monetarist theory of inflation, which is based on the quantity theory of money, and the wage-pressure theory, which is also advocated by Keynesians, cannot explain the recent rise in inflation rates. Neither can it be explained by an excessive increase in the money supply, nor by a disproportionate increase in wages.

A more plausible explanation is that pandemic-induced disruptions in international supply chains contributed to inflation. Production, which was severely curtailed in 2020 due to the pandemic, could not keep up with the upswing in demand in 2021. The decline in investment in fossil fuels, coupled with Russia’s cuts to gas supplies following the conflict over the North Stream 2 pipeline in the summer of 2021, likely also contributed to the rise in fossil fuel prices. Energy and food prices in particular were then driven up further by the escalation of the war in Ukraine, exacerbated both by sanctions imposed by the West, and by Russian counter-sanctions.

The inflation theories of mainstream economics are obviously implausible, but critical debate about the new wave of inflation is still in its infancy. The significance of monopolies or oligopolies for inflation, for example, is disputed in Marxist debates. More attention also needs to be paid to the role of speculative price formation on the commodity futures exchanges. How an analysis of current inflation can be reconciled with the Marxian theory of the capitalist mode of production and with a general theory of inflation remains to be discussed.[4]

[1] The following figures are based on the German Federal Statistical Office’s data on “compensation of employees” and the “harmonized consumer price index”.

[2] The following figures are based on data from the National Income and Product Accounts (NIPA) of the Bureau of Economic Analysis (BEA), data from Eurostat, and our own calculations.

[3] Frank Umbach, Erdgas als Waffe. Der Kreml, Europa und die Energiefrage, Berlin: edition.fotoTAPETA, 2022, p. 46ff.

[4] See, for example, Anwar Shaikh, Capitalism, Oxford: Oxford University Press, 2016, pp. 44ff, 677ff; Michael Roberts and Guglielmo Carchedi, Capitalism in the 21st Century: Through the Prism of Value, London: Pluto, 2023, pp. 75ff.