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Brutal news: US inflation hits 7.5%, 40 year high

Last year, when inflation began to infect the western economy, there were no shortage of economists – including the US Federal Reserve – out in the media to assure people that the problem was “transitory”, and connected to “supply chain bottlenecks”.

They’ve all suddenly gone a bit quiet:

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.6 percent in January on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 7.5 percent before seasonal adjustment.

The worst bit? This increase in prices came despite a small reduction in the price of fuel, in the USA (where taxes on fuel are a fraction of what they are in Ireland):

The energy index also increased 0.9 percent over the month, with an increase in the electricity index being partially offset by declines in the gasoline index and the natural gas index.

Here is the core problem, and the problem which every politician in the western world will avoid admitting at all costs: The only known cure for inflation is recession. Interest rates go up, tightening the money supply. The point of tightening the money supply is to reduce demand, and therefore stabilise prices. The problem is that reducing demand by reducing the money supply necessarily means making people worse off in the medium term, to stave off a bigger problem in the longer term.

The root cause of this problem – again, despite what politicians will admit – is that for the better part of a decade, fiscal and monetary economic policy has been actively inflationary. Remember Joe Biden’s big fiscal stimulus “covid recovery” bill? That pumped nearly a trillion dollars into the US economy. In Ireland, we have been on a massive spending splurge throughout covid, ramping up public spending even as many people accumulated piles of savings. In addition to that, both the US federal reserve and the European Central Bank have engaged over the past decade in several rounds of “bond purchases” or “quantative easing”, which is fancy-speak for “printing more money”. Now, with covid at an end, much of that money is flowing directly into the economy, driving rocketing demand, and rocketing prices.

Add to all of that policies on climate change, alcohol, and various other issues which actively seek to drive prices up, and the west as a whole (not just Ireland) is facing into a proper economic crisis.

The immediate near term result of this will be – as a matter of near certainty – that interest rates will rise this year, which will hurt people who have mortgages, and (in theory) reward people who save their money, rather than spend it. The objective of increasing interest rates is to encourage people to spend less money, and take some of the heat out of the economy.

But of course, that encouragement does not only extend to families, but to firms, too.

To put this in some historic context, Margaret Thatcher’s reputation for economic brutality largely stems from her campaign to eradicate inflation in Britain in the early 1980s. Some of you might remember her “the lady’s not for turning” speech: That was in relation to inflation policy. The BBC summarises what she did:

One of Margaret Thatcher’s first goals was taming inflation which had reached dizzying heights of over 25% in the mid-1970s.

The incoming Conservative government raised interest rates sharply and brought in tough public spending curbs.

A recession followed and unemployment shot up. This also led to reduced wage demands and a slowing of the rate of inflation, although this crept up once more in the boom of the late 1980s.

The good news here is that inflation has not hit 25%, as it did in Britain in the 1970s. The bad news is that if you want to combat inflation, raising interest rates and cutting spending is the only thing that works.

And of course, the Irish Government does not control interest rates. Public spending is their one tool.

Unless this problem magically disappears all by itself, then politicians – and we, the public – are in line for a whole world of pain, over the next two to three years. These figures from the USA should be triggering a red alert fire alarm in Government buildings. We are not immune. The problem is already here, and it is going to get worse, before it gets better.

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