The last thing policy makers should be thinking about right now is creating a recession

There was an informative article in the UK Guardian over the week (January 13, 2022) – Australia’s supply chain issues likely to continue despite drop in Covid cases – which documented the many ways in which the pandemic has led to difficulties in getting goods supplied to retail outlets or their destination (in the case of overseas mail deliveries). The majority of recent articles about the economy and policy options have erred on the side of the need for interest rate hikes and fiscal policy cutbacks, which assume the rising inflation rates around the world are the demand-side events. But it is obvious to anyone other than private bank economists who are lobbying for interest rate rises to increase the profits for their banks, or, mainstream economists, who oppose central bank bond-buying and fiscal deficits, that the cause of the problems at present is not being driven by an explosion of nominal spending – neither from the non-government sector or through fiscal policy. Here is some more evidence to support that conclusion.

The UK Guardian article quoted the boss of the Australian Retail Association, who said the on-going shortage of goods available :

… is due to the sheer volume of products and supplies within the global supply chain and the profound shortage of freight space on ships, shipping containers and pallets exacerbated by the limited flights into the country

If the supply contracts, at the same time as incomes are largely intact, then it is likely there will be price pressures.

But the causality is coming from the abnormal event – the supply constraints.

The UK Guardian article also noted the behaviour of unregulated cartels, who quickly move in to profit when these imbalances occur.

We read:

All these shipping lines are registered to countries such as Panama, Mexico, the Dominican Republic and things like that, so they’re not really regulated …

So essentially, they’re modern day pirates at the moment because the prices are not really controlled or regulated by any government.

That is an industry policy question rather than a fiscal or monetary policy issue.

Further, we know that many distribution centres around the world are in chaos because “up to half the staff … were off work at any one time.”

All of which tells me that when the abnormal consequences of the pandemic abate, things will settle pretty quickly. But not before. And before could be several years.

The policy advice then is to be patient and not be flustered by the current spikes in inflation rates, especially when the mechanisms that would be needed to solidify these supply constraints into a full-blow distributional struggle of real shares of national income between workers and capital is not evident yet.

Personal Consumption Expenditure in the US is declining

One indicator to watch is the trajectory of Personal Consumption Expenditure (PCE). I have been following the recent shifts in the US data, given that nation seems to be having the highest price levels shifts in the advanced world at present.

We will get an update from the US Bureau of Economic Analysis for January on February 25, 2022, but the last several months provides a guide to what has been happening.

The most recent release (January 28, 2022) – Personal Income and Outlays, December 2021 – told us that:

Personal income increased $70.7 billion (0.3 percent) in December … Disposable personal income (DPI) increased $39.9 billion (0.2 percent) and personal consumption expenditures (PCE) decreased $95.2 billion (0.6 percent) …

… and Real PCE decreased 1.0 percent; goods decreased 3.1 percent and services increased 0.1 percent.

Read: “decreased”.

But also the shift in composition is important to understand.

In this blog post – Central banks are resisting the inflation panic hype from the financial markets – and we are better off as a result (December 13, 2021) – I noted that both the productive and spending sides of the economy interact to create an inflationary episode.

But the important point is to understand how that interaction changes to motivate a shift from stable prices to rising prices and then accelerating prices.

I showed that the pandemic, which is a highly unusual event by any stretch, has created a major imbalance in the relationship between spending and production.

The pandemic did three things in this context.

First, the government stimulus payments, though imperfect, helped maintain incomes and spending capacity among households.

Second, the lockdowns prevented consumers spending on services by and large – hospitality, entertainment, travel etc.

And with income still intact, the spending shifted to goods-production – renovations, gadgets, flat-screen TVs, you name it.

Households brought forward spending plans on some goods purchases while normal spending patterns were short-circuited by the inability to spend on services.

Third, the lockdowns and health concerns also reduced the capacity of the goods-producing sector to meet the new demand. This is what we are referring to when we talk about supply-side bottlenecks.

If workers are locked down, getting sick, and ports and freight terminals are disrupted, the normal smooth supply chain is interrupted and so there are inventory shortfalls, delivery delays and the like.

Then overlay market power – which allows producers, wholesalers and retailers to profit gouge the shortages via mark-up increases and you see the problem.

So there has been a fairly rapid shift in spending patterns towards goods demand as service demand fell, while the supply-side for goods oduction has not been able to meet that shift quickly enough and there has been massive buildup of excess capacity in the services sector.

As I have previously noted, I am surprised the inflationary pressures have not been greater given this combination of events.

But, I still argue that these spending shifts and production constraints will give way once we move beyond the pandemic, and you can see that happening a but already.

The next graph shows, for the US, which has the highest inflation response in the advanced nations, the monthly growth in nominal and real PCE over the last several months in 2021.

Focus on the nominal aggregate because this tells us the growth in dollars that households are spending on consumption goods and services in total.

The real aggregate reflects the inflation impact on that nominal spending.

Conclusion: consumer demand is falling not increasing. It is hard to claim the inflation is being driven by demand forces.

The next graph shows the trajectory of PCE since the March-quarter 2010 and the orange line is the trend extrapolated from the average monthly growth rate between the December-quarter 2017 and the December-quarter 2019 (last 8 quarters before the pandemic impacted).

Remember that this is quarterly data. The reason I say that is because as the first graph shows, over the course of the December-2021 quarter, each successive month has seen PCE growth decline, to the point that the monthly observation for December 2021 was negative.

But even using the quarterly data, the catch-up since the pandemic trough has really only put PCE back onto its previous trend.

Which means that there doesn’t appear to be a blow out occurring in nominal PCE in the US and the last month, Xmas spending notwithstanding revealed negative growth.

Fiscal stimulus and inflation

I have also compiled a database using data from the IMF – Fiscal Monitor Database of Country Fiscal Measures in Response to the COVID-19 Pandemic (last updated October 2021) and – Consumer Price Index (CPI) – data from their Macroeconomic and Financial Data repository.

The IMF fiscal database:

… summarizes key fiscal measures governments have announced or taken in selected economies in response to the COVID-19 pandemic as of September 27, 2021 for 20 G20 Advanced and Emerging Market Economies, 26 Non-G20 Advanced Economies, 82 Non-G20 Emerging Market Economies, 59 Low-Income Developing Countries. It includes COVID-19 related measures since January 2020 and covers measures for implementation in 2020, 2021, and beyond. The database categorizes different types of fiscal support (for example, above-the-line and below-the line measures, and contingent liabilities) that have different implications for public finances in the near term and beyond … It focuses on government discretionary measures that supplement existing automatic stabilizers.

Matching that data with the inflation data is not straightforward.

But, after cleaning the data (to remove null observations, and anomalies), I ended up with 122 countries including all the advanced nations, but also including many so-called ’emerging markets’ nations, and ‘Low-income Developing Countries’.

The annual inflation rate used varies between the September 2021 observation and the December 2021 observation, with the latter being used for the majority of nations. For some nations, only the first observation was available, for others, the October 2021 observation and so on.

The first graph plots the fiscal stimulus response in per cent of GDP for each nations on the horizontal axis and the corresponding inflation rate on the vertical axis.

The red dotted line is a simple, linear regression through the observations.

Now the first point to emphasise is these cross plots may disguise causality and/or omit other variables that jointly cause the two shown.

Remember though that the fiscal measure is the discretionary measures separate from the cyclical effects (automatic stabilisers). So the measure reflects explicit government policy in dealing with the pandemic.

Further, while we can only say so much based on a cross plot, it would be hard to mount a case, even with more sophisticated statistical analysis (isomg hard core econometric techniques, etc), that there was a significant relationship between the inflation outcome and the fiscal response to the stimulus.

The red dotted line indicates a negative relationship but the underlying statistical diagnostics suggest no relationship.

One might note the outliers – Argentina with an inflation rate of 50.94 per cent, Haiti 24.6 per cent, Turkey 36.1 per cent, and Zimbabwe 51.6 per cent.

Does this distort the graph?

Well I deleted those observations to produce this graph.

Answer: the dotted line is still downward sloping, so the higher inflation outliers don’t change the conclusion.

There is no clear relationship between the fiscal measures taken by governments to deal with the pandemic and their nation’s recent inflation experience.

Again – the demand-side is not driving this current inflation episode.


The point is that calls for interest rate rises are in denial of these insights.

Even worse, are calls for fiscal cutbacks.

There was an article from the Executive Editor for Bloomberg (reproduced in the Melbourne Age) – The Fed may have to force a recession to get inflation under control (February 11, 2022) – which really summarises how far fetched some analysis has become.

The writer claims that the “money markets priced in the possibility that the central bank will be forced to raise interest rates higher and faster than it has projected”, which just says the speculators have placed bets on that and are enlisting all sources of pressures, including captive journalists, to lobby the central bank to ratify their bets and allow them to make millions.

The conclusion the writer reaches is:

What all this means is that the markets increasingly see the only way for the Fed to get inflation under control is to engineer a sharp slowdown in the economy, and perhaps even force a recession.

Manic really.

The world economy is still well short of where it was pre-pandemic, and the pre-pandemic situation was hardly glowing with prosperity for those outside the top 10 per cent of the income distribution, and particularly, for low-paid workers.

The US economy is well short of its pre-pandemic employment level.

Wages growth has been suppressed around the world for years and any sign that things are changing is for the better and should not be seen as a justification for quashing it with recession-targetted policy.

The last thing any policy maker should be aiming for at present is a recession or even a “sharp slowdown”. You can be sure that the only ones damaged by that sort of strategy will be the workers, while the banksters will get away with millions.

And, a recession will not ease the supply constraints.

It would just bring the demand side down in line with the reduced supply capacities at present, cause massive income and job losses, and then, sometime in the future, as the pandemic eases, and ships and trucks start moving again, we would all wonder what the hell it was all for.

Well, it would be clear what the motivation would have been.

Continue the transfer of national income to the top-end-of-town and keep the workers from gaining some much needed real wages growth


Policy makers should ignore the noise from the financial markets and decline to ratify their gambling.

They should be patient and let the supply side constraints ease as the pandemic eases. Their attention should be on protecting the health of their populations and ensuring people can work safely.

The last thing they should be thinking about is creating a recession.

Our edX MOOC – Modern Monetary Theory: Economics for the 21st Century continues

We are off and running again for another year with the first day of our MMTed/University of Newcastle MOOC – Modern Monetary Theory: Economics for the 21st Century.

The course is free and will run for 4-weeks with new material each Wednesday for the duration.

It is not to late to enrol and became part of the already large class.

Learn about MMT properly with lots of videos, discussion, and more.

This year there will be some live interactive events offered to participants, which adds to the material presented previously.

So even if you completed the course last year, these live events might be a reason for doing it again.

Further Details:

If you want to do the course, get in early as then you avoid having to catch up.

All are welcome.

That is enough for today!

(c) Copyright 2022 William Mitchell. All Rights Reserved.